Common Size Financial Statement - Explained
What is a Common Size Financial Statement?
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What is a Common Size Financial Statement?
A common size financial statement is a financial statement or balance sheet that presents itself as a percentage of the base number of sales or assets. The process of creating a common size financial statement is known as common-size analysis or vertical analysis.
The financial statement reports owner equity, assets, and liabilities as percentages of the total assets. A financial statement like this gives the analysts an easier time when analyzing the profits of a company at different periods.
How is a Common Size Financial Statement Used?
Note that most companies do not use the common size format to report their financial statements. Comparing two different companies in different economic sectors can be easier when using common size financial statements. Using percentages allows one to see changes in values over time. Managers can also use the data to come up with new operations strategies. Balance sheets, income statements, and cash flow statements are examples of common size financial statements.
Common Size Analysis
Types of common size financial statements
Common size financial statements are of various types, and each type makes use of different financial figures for standardization. The following are the types of common size statements:
Common size balance sheet
A balance sheet gives a summary of the equity fund, liabilities, and assets of a company over time. The period can be quarterly or annually. In a balance sheet; assets = liabilities + stockholders' equity In a common size balance sheet, the items present themselves as percentages of their base numbers. The assets are a percentage of the total assets. The same applies to liabilities and equity funds.
Common size income statements
Most people refer to the income statement as a profit or loss statement. It provides an outline of expenses incurred, sales, and net income in a given financial reporting time. The income statement presents all items as a percentage of the total sales In an income statement; net income = sales expenses
Common size cash flow statements
A cash flow statement shows the way cash is moving in and out of the firm. It also provides information about the sources and usage of money. Cash flows from the firms investments, cash flows from daily operations, and flows from financing are the subdivisions of the cash flow statement.
Limitations of common size financial statements
In general, financial statements present various limitations due to different interpretations when constructing the data. The limitations include:
- Companies using varying accounting policies when generating financial statements at different times. The same company could also be using different policies. The financial analysts need to adjust the data to ensure they are using the same policies to generate financial statements.
- Difficulty when comparing accounting periods as the companies may be using dissimilar accounting calendars.
- Inconsistencies in the preparation of financial statements make the common size aspect irrelevant when evaluating the performance of a firm.
- Common size financial statements do not provide concrete information to its users when there are fluctuations in the different financial components.
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