Common Size Statement

 

Welcome, Class 12 Commerce students! Today, we'll be exploring an important financial analysis tool - the Common Size Statement. This tool is crucial for investors, analysts, and business owners to understand the financial position and performance of a company over time or in comparison with other companies.

What is a Common Size Statement?

A Common Size Statement is a financial statement in which each line item is expressed as a percentage of a significant total. This technique can be applied to both the balance sheet and the income statement. For the balance sheet, each item is expressed as a percentage of total assets or total liabilities plus equity. For the income statement, each item is expressed as a percentage of sales or revenue.

Why Use Common Size Statements?

1. Comparability: It allows for the comparison of companies of different sizes by standardizing the data.
2. Trend Analysis: Analysts can easily identify trends over time within a company.
3. Identifying Proportional Changes: It helps in identifying changes in the financial structure of a company.

How to Prepare a Common Size Statement

For an Income Statement:

1. Determine the Base: The base is usually total sales or revenue.
2. Calculate the Percentage: Each item on the income statement is divided by the total sales and then multiplied by 100 to find the percentage.

Example:

• Total Revenue = ₹200,000
• Cost of Goods Sold (COGS) = ₹120,000

COGS as a percentage of Total Revenue = (₹120,000 / ₹200,000) * 100 = 60%

For a Balance Sheet:

1. Determine the Base: The base can be total assets or total liabilities and equity.
2. Calculate the Percentage: Each item on the balance sheet is divided by the total base figure and then multiplied by 100 to find the percentage.

Example:

• Total Assets = ₹500,000
• Inventory = ₹100,000

Inventory as a percentage of Total Assets = (₹100,000 / ₹500,000) * 100 = 20%

Advantages of Common Size Statements

• Ease of Analysis: Simplifies complex financial statements and makes them understandable.
• Efficiency: Facilitates quick comparison and analysis, saving time for analysts and investors.
• Versatility: Useful in analyzing both internal company performance and comparative performance across companies.

Limitations of Common Size Statements

• Not a Standalone Tool: Should be used in conjunction with other financial analysis tools for comprehensive analysis.
• Quality of Data: The accuracy of analysis depends on the quality of the underlying financial statements.
• No Insight on Market Conditions: Does not provide information about market conditions or external factors affecting the business.

Conclusion

Common Size Statements are a powerful tool for financial analysis, offering clear insights into the financial structure and operations of a company. By converting financial statements into percentage terms, they allow for easy comparison across companies and time periods, highlighting trends and changes in financial performance. However, it's important to remember that they should be used as part of a broader analysis that includes other financial metrics and market context.

Homework: Choose two companies from different sectors and prepare their common size income statements using their most recent annual reports. Analyze the differences in their cost structures and profitability.