Common-size financial statement
| Common-size financial statement |
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A definition of a common-size financial statement determines a balance sheet or an income statement in which each line items are represented as a percent of assets or sales, respectively[1].
Vertical analysis
One type of vertical analysis takes advantage of financial statements that contain only percents. Each element of the financial statement is registered as a percent of some amount of some mutual item in the statement. Statements of this model are called common-size financial statements. Common-size financial statements are different from statements prepared for vertical analysis because in that common-size financial statements include only percentages and not dollar amounts. All figures included on a common-size balance sheet are the percent of total liabilities or total assets plus stockholders' equity. The items are percents of net sales on a common-size income statement. In the statement of cash flows, every item is a percent of the decrease or increase in cash inflows for the year. The items always sum to 100% so this type of presentation is "common-size". Common-size statements let the user to better understand:
- the change in cash and the item (on the statement of cash flows),
- the sales (on the income statement),
- the relationship between a particular item or
- between total assets and an item or
- total liabilities plus stockholders' equity (on the balance sheet).
Such statements might give the reader a better understanding which might be gained by only looking at absolute dollar amounts[2].
Example of the common-size financial statement
Moreover, common-size financial statements also let comparisons to be made between corporations of different sizes. One of the examples can be General Motors Corporation which is much bigger than Chrysler Corporation and the comparison is difficult. However, supposing the modification of the financial statements of each company becomes to common-size, so the changes become apparent in the relative size of the elements of the financial statements. These changes can be missed if just absolute dollar amounts are examined, (for example, a company's sales might increase, giving a positive signal, but if gross margin selling or decreased, administrative and general expenses increased as a percent of sales, the benefit of additional sales might be lost). Common-size financial statements expose both types of change[3].
Footnotes
References
- Albrecht W., Stice J., Stice E., Swain M., (2007)., Accounting: Concepts and Applications, Cengage Learning
- Loughran M.,(2011)., Financial Accounting for Dummies, John Wiley and Sons
- Plewa F. J., George J., Friedlob T., (1995)., Understanding Cash Flow, John Wiley and Sons
- Wahlen J.M., Baginski S.P., Bradshaw M., (2017)., Financial Reporting, Financial Statement Analysis and Valuation, Cengage Learning
Author: Agnieszka Piwowarczyk
