Common Size Financial Statement: Definition, Overview & Formula

Conducting a common size balance sheet analysis can let you quickly see how your assets and liabilities stack up. Ideally, you want a low liability-to-asset ratio, as this indicates you will be able to easily pay your business’s obligations. This low ratio is favorable especially if you’re applying for a business loan, since lenders want to be assured that you’re financially solvent enough to take on and repay additional debt. Common size financial statements make it easier to determine what drives a company’s profits and to compare the company to similar businesses.

The same formula can be copied and replicated in each income statement line, making the calculations much faster. In Figure 5.21, you can see the formulas used to create Clear Lake Sporting Goods’ common-size income statement in Excel. Notice that the $ can be inserted to anchor a cell reference, making it easier to copy and paste the same formula onto many lines or columns. Doing so will help you see at a glance which expenses take up the largest percentage of your revenue. Using common size percentages allows you to gain a different perspective of each line item.

The balance sheet equation is assets equals liabilities plus stockholders’ equity. The base item in the income statement is usually the total sales or total revenues. Common size analysis is used to calculate net profit margin, as well as gross and operating margins. Common size analysis can be conducted in two ways, i.e., vertical analysis and horizontal analysis. Vertical analysis refers to the analysis of specific line items in relation to a base item within the same financial period.

Analyzing Organizational Performance

For example, if the value of long-term debt in relation to the total assets value is high, it may signal that the company may become distressed. The common-size strategy from a balance sheet perspective lends insight into a firm’s capital structure and how it compares to its rivals. You can also look to determine an optimal capital structure for a given industry and compare it to the firm being analyzed. You can then conclude whether the debt level is too high, if excess cash is being retained on the balance sheet, or if inventories are growing too high.

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Using Clear Lake Sporting Goods’ current balance sheet, we can see how each line item in its statement is divided by total assets in order to assemble a common-size balance sheet (see Figure 5.22). The analysis shows that the sample company had a positive influx of cash from operating activities in 2022, but this was overshadowed by a bigger increase in expenditures on investment items. Ultimately, positive cash flow from financing activities left the business with a positive cash position of $13,000.

In this next section we will explore the requirements for what needs to be reported, when, and to whom. ABC’s profitability may be lower, but its cash generation abilities cannot be questioned and so bankruptcy risk will be minimal and there will be no shortage of investors trying to get in on the action. And there is no reason ABC cannot reach XYZ’s labor costs over time, which would immediately drive profits up.

Such a strategy may allow the company to grow faster than comparable companies. To calculate net income, you subtract the cost of goods sold, selling and general administrative expenses, and taxes from total revenue. After some calculations, you determine the revenue for the company to be $100,000.

For example, in the balance sheet, we can assess the journal entry template download free excel template proportion of inventory by dividing the inventory line using total assets as the base item. With regular financial statements, you would have line items listed as their total amounts. When it comes to common size financial statements, each line item gets expressed as a specific percentage of revenue or sales. On the Clear Lake Sporting Goods’ common-size balance sheet, we see that current assets remained at 80 percent of total assets from the prior to current year (see Figure 5.25). While the balance in the equipment account did change as a percentage of total assets, equipment remained the same at 20 percent. It also shows the impact of each line item on the overall revenue, cash flow or asset figures for your company.

The common size balance sheet reports the total assets first in order of liquidity. Liquidity refers to how quickly an asset can be turned into cash without affecting its value. For this reason, the top line of the financial statement would list the cash account with a value of $1 million. The common-size bookkeeping and accounting services in colorado balance sheet functions much like the common-size income statement. Each line item on the balance sheet is restated as a percentage of total assets.

1. With regular financial statements, you would have line items listed as their total amounts.
2. One item of note is the Treasury stock in the balance sheet, which had grown to more than negative 100% of total assets.
3. But rather than act as an alarm, this indicates that the company had been hugely successful in generating cash to buy back shares, far exceeding what it had retained on its balance sheet.
4. A common size financial statement is used to analyze any changes in individual items when it comes to profit and loss.
5. Owner equity, assets, and liabilities are shown in the financial statement as a percentage of total assets.

What is Common Size Analysis?

Common-size statements allow Clear Lake to compare their statements in a meaningful way (see Figure 5.26). Notice that Clear Lake spends 50 percent of its sales on cost of goods sold while Charlie spends 59 percent. This is a significant difference that would be an indicator that Clear Lake and Charlie have key differences in their operations, purchasing policies, or general performance in their core products. On the debt and equity side of the balance sheet, however, there were a few percentage changes worth noting.

And, just like with the income statement, we must compare our numbers with the industry’s averages or with major competitors. With a common size horizontal analysis, you can easily see if, for example, your expenses increased as a percentage of revenue, stayed the same or decreased among different time periods. You can use it to see how your business stacks up percentage-wise with another business, even if that business is substantially larger.

Rapid increases or decreases will be readily observable, such as a fast drop in reported profits during one quarter or year. It’s worth noting that if two companies are using different accounting methods the comparisons might not be accurate. The goodwill level on a balance sheet also helps indicate the extent to which a company has relied on acquisitions for growth. XYZ has stability and better profitability, so seemingly it may be a better long-term alternative. Many, or all, of the products featured on this page are from our advertising partners who compensate us when you take certain actions on our website or click to take an action on their website.