A company financial statement that displays all items as percentages of a

common base figure. This type of financial statement allows for easy analysis
between companies or between time periods of a company.
Doing a Common Size analysis
Common size is a very helpful technique for identifying trends and changes in your
company. It can be used on any of the three financial statements. Its value is that it is
much easier to see trends and changes in percentage terms than in raw numbers.
Therefore, it makes it easier to compare a companys performance over time and to
compare two or more companies, especially companies of different sizes.
To get a sense of how your company is performing compared to others in the same
industry, you also can look at industry averages. Industry averages are especially
helpful if they are broken into groups by revenues or some other important metric for the
industry. If your company were Nordstrom, you would find it helpful to see how
Nordstrom compared with other clothing retailers.
How to calculate it
Calculating Common Size for the Income Statement is simple divide all entries for the
same year on the statement by revenues (sales or net sales on some Income
Statements). In other words, if you are looking at the results for 2010, divide revenue for
that year into all the other entries for that year (or, if you prefer different terminology,
divide the entries by revenue). Notice you are working down the column, staying in the
same year. Use 2010 revenue for that year, 2009 revenue for that year, etc.
Analyzing the numbers
After you have calculated the percentages and entered them in your spreadsheet, you
should to work from oldest year to most recent year in analyzing the percentages.
What it shows you
Common Size allows you to see how Cost of Goods Sold (and, conversely, Gross Profit
Margin) has moved over the time period. You also can see how Sales, General and
Administrative, Operating Profit Margin, Net Profit Margin and the other entries are
moving over the time period.
This allows you to determine WHY a companys financial performance has developed
as it has.
What is the difference between
vertical analysis and horizontal
analysis?
Vertical analysis reports each amount on a financial statement as a percentage of another item.
For example, the vertical analysis of the balance sheet means every amount on the balance sheet
is restated to be a percentage of total assets. If inventory is $100,000 and total assets are
$400,000 then inventory is presented as 25 ($100,000 divided by $400,000). If cash is $8,000
then it will be presented as 2 ($8,000 divided by $400,000). The total of the assets will now add
up to 100. If the accounts payable are $88,000 they will be presented as 22 ($88,000 divided by
$400,000). If owner's equity is $240,000 it will be presented as 60 ($240,000 divided by
$400,000). The restated amounts from the vertical analysis of the balance sheet will be presented
as a common-size balance sheet. A common-size balance sheet allows you to compare your
company's balance sheet to another company's balance sheet or to the average for its industry.

Vertical analysis of an income statement results in every income statement amount being
presented as a percentage of sales. If sales were $1,000,000 they would be restated to be 100
($1,000,000 divided by $1,000,000). If the cost of goods sold is $780,000 it will be presented as
78 ($780,000 divided by sales of $1,000,000). If interest expense is $50,000 it will be presented
as 5 ($50,000 divided by $1,000,000). The restated amounts are known as a common-size
income statement. A common-size income statement allows you to compare your company's
income statement to another company's or to the industry average.

Horizontal analysis looks at amounts on the financial statements over the past years. For
example, the amount of cash reported on the balance sheet at December 31 of 2012, 2011, 2010,
2009, and 2008 will be expressed as a percentage of the December 31, 2008 amount. Instead of
dollar amounts you might see 134, 125, 110, 103, and 100. This shows that the amount of cash at
the end of 2012 is 134% of the amount it was at the end of 2008. The same analysis will be done
for each item on the balance sheet and for each item on the income statement. This allows you to
see how each item has changed in relationship to the changes in other items. Horizontal analysis
is also referred to as trend analysis.
General Discussion of Balance Sheet
The balance sheet reports a company's assets, liabilities, and stockholders' equity as of a specific date, such
as December 31, 2013, March 31, 2013, etc.
The accountants' cost principle and the monetary unit assumption will limit the assets reported on the balance
sheet. Assets will be reported
(1) only if they were acquired in a transaction, and
(2) generally at an amount that is not greater than the asset's cost at the time of the transaction.
This means that a company's creative and effective management team will not be listed as an asset. Similarly,
a company's outstanding reputation, its unique product lines, and brand names developed within the company
will not be reported on the balance sheet. As you may surmise, these items are often the most valuable of all
the things owned by the company. (Brand names purchased from another company will be recorded in the
company's accounting records at their cost.)
The accountants' matching principle will result in assets such as buildings, equipment, furnishings, fixtures,
vehicles, etc. being reported at amounts less than cost. The reason is these assets
are depreciated.Depreciation reduces an asset's book value each year and the amount of the reduction is
reported as Depreciation Expense on the income statement.
While depreciation is reducing the book value of certain assets over their useful lives, the current value (or
fair market value ) of these assets may actually be increasing. (It is also possible that the current value of
some assetssuch as computersmay be decreasing faster than the book value .)
Current assets such as Cash, Accounts Receivable, Inventory, Supplies, Prepaid Insurance, etc. usually have
current values that are close to the amounts reported on the balance sheet.
Current liabilities such as Notes Payable (due within one year), Accounts Payable, Wages Payable, Interest
Payable, Unearned Revenues, etc. are also likely to have current values that are close to the amounts reported
on the balance sheet.
Long-term liabilities such as Notes Payable (not due within one year) or Bonds Payable (not maturing within
one year) will often have current values that differ from the amounts reported on the balance sheet.
Stockholders' equity is the book value of the company. It is the difference between the reported amount of assets
and the reported amount of liabilities. For the reasons mentioned above, the reported amount of stockholders'
equity will therefore be different from the current or market value of the company.
By definition the current assets and current liabilities are "turning over" at least once per year. As a result, the
reported amounts are likely to be similar to their current value. The long-term assets and long-term liabilities
arenot "turning over" often. Therefore, the amounts reported for long-term assets and long-term liabilities will
likely be different from the current value of those items.
The remainder of our explanation of financial ratios and financial statement analysis will use information from
the following balance sheet:








Common-Size Balance Sheet
One technique in financial statement analysis is known as vertical analysis. Vertical analysis results in
common-size financial statements. A common-size balance sheet is a balance sheet where every dollar
amount has been restated to be a percentage of total assets. We will illustrate this by taking Example
Company's balance sheet (shown above) and divide each item by the total asset amount $770,000. The result
is the following common-size balance sheet for Example Company:

The benefit of a common-size balance sheet is that an item can be compared to a similar item of
another company regardless of the size of the companies. A company can also compare its
percentages to the industry's average percentages. For example, a company with Inventory at 4.0%
of total assets can look to its industry statistics to see if its percentage is reasonable. (Industry
percentages might be available from an industry association, library reference desks, and from
bankers. Many banks have memberships in Risk Management Association (RMA), an organization
that collects and distributes statistics by industry.) A common-size balance sheet also allows two
businesspersons to compare the magnitude of a balance sheet item without either one revealing the
actual dollar amounts.
Financial Ratios Based on the Balance
Sheet
Financial statement analysis includes financial ratios. Here are three financial ratios that are based solely on
current asset and current liability amounts appearing on a company's balance sheet:

Four financial ratios relate balance sheet amounts for Accounts Receivable and Inventory to income statement
amounts. To illustrate these financial ratios we will use the following income statement information:

To learn more about the income statement, go to:
Explanation of Income Statement
Quiz for Income Statement
Crossword Puzzle for Income Statement

The next financial ratio involves the relationship between two amounts from the balance sheet: total liabilities
and total stockholders' equity:


General Discussion of Income Statement
The income statement has some limitations since it reflects accounting principles. For example, a company's
depreciation expense is based on the cost of the assets it has acquired and is using in its business. The
resulting depreciation expense may not be a good indicator of the economic value of the asset being used up.
To illustrate this point let's assume that a company's buildings and equipment have been fully depreciated
and therefore there will be no depreciation expense for those buildings and equipment on its income
statement. Is zero expense a good indicator of the cost of using those buildings and equipment? Compare that
situation to a company with new buildings and equipment where there will be large amounts of depreciation
expense.
The remainder of our explanation of financial ratios and financial statement analysis will use information from
the following income statement:

To learn more about the income statement, go to:
Explanation of Income Statement
Quiz for Income Statement
Crossword Puzzle for Income Statement
Common-Size Income Statement
Financial statement analysis includes a technique known as vertical analysis. Vertical analysis results in
common-size financial statements. A common-size income statement presents all of the income statement
amounts as a percentage of net sales. Below is Example Corporation's common-size income statement after
each item from the income statement above was divided by the net sales of $500,000:

The percentages shown for Example Corporation can be compared to other companies and to the industry
averages. Industry averages can be obtained from trade associations, bankers, and library reference desks. If
a company competes with a company whose stock is publicly traded, another source of information is that
company's "Management's Discussion and Analysis of Financial Condition and Results of Operations"
contained in its annual report to the Securities and Exchange Commission (SEC). This annual report is the
SEC Form 10-K and is usually accessible under the "Investor Relations" tab on the corporation's website.
Financial Ratios Based on the Income
Statement

Statement of Cash Flows
The statement of cash flows is a relatively new financial statement in comparison to the income statement or
the balance sheet. This may explain why there are not as many well-established financial ratios associated with
the statement of cash flows.
We will use the following cash flow statement for Example Corporation to illustrate a limited financial statement
analysis:

The cash flow from operating activities section of the statement of cash flows is also used by some analysts to
assess the quality of a company's earnings. For a company's earnings to be of "quality" the amount of cash
flow from operating activities must be consistently greater than the company's net income. The reason is that
under accrual accounting, various estimates and assumptions are made regarding both revenues and
expenses. When it comes to cash, however, the money is either in the bank or it isn't.