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How to Use Common Size Analysis to Compare Companies to Peers

ByMarkus Bauer

Dec 30, 2020

common sizing analysis

Chances are, you already do at least a partial common size income statement analysis each month. Whenever you analyze your margins — gross profit, net profit or operating — you’re performing a common size analysis. The technique can be used to analyze the three primary financial statements, i.e., balance sheet, income statement, and cash flow statement. In the balance sheet, the common base item to which other line items are expressed is total assets, while in the income statement, it is total revenues. Generally accepted accounting principles (GAAP) are based on consistency and comparability of financial statements.

Let’s perform some common size analysis using both the income statement and balance sheet—the company I would like to use Paypal (PYPL) as our guinea pig. For instance, ratio analysis can provide concrete numerical values reflecting a company’s financial performance, while common size analysis offers a view into how income or assets are distributed. Conducting a horizontal analysis requires choosing a base year and then calculating the percentage change of each line item from that base year. So, if a company’s revenue increased from $50,000 in the base year to $75,000 in the current year, then the revenue has increased by 50%.

That might indicate the company is expanding its operations and taking market share from its peers. The most significant benefit of a terminal value formula common-size analysis is that it can let you identify large or drastic changes in a firm’s financials. Rapid increases or decreases will be readily observable, such as a fast drop in reported profits during one quarter or year. The key benefit of a common-size analysis is that it allows for a vertical analysis by line item over a single period, such as quarterly or annually. It also allows you to view a horizontal perspective over a period such as the three years that were analyzed in our example.

  1. However, net income only accounted for 10% of 2022 revenue, whereas net income accounted for more than a quarter of 2021 revenue.
  2. Common size analysis is a financial analysis technique that converts line items of financial statement of a company into a percentage of a selected or common figure such as sales or total assets.
  3. It not only benchmarks against competitors but also identifies financial trends, making it a foundation of sound economic and financial decisions.
  4. By asserting the financial implications of these initiatives, companies can enrich their reporting process and succeed in their sustainability journey.
  5. In contrast, common size analysis converts this information into percentages of a reference value, such as total revenue or total assets.

Common Size Income Statement

common sizing analysis

It provides insights into how a company’s performance and financial health have changed over time, which can be instrumental in predicting future performance. In summary, common size analysis is an invaluable tool for strategic decision-making, performance evaluation, and financial planning across sectors. It not only benchmarks against competitors but also identifies financial trends, making it a foundation of sound economic and financial decisions. Doing so will help you see at a glance which expenses take up the largest percentage of your revenue. For example, large drops in the company’s profits in two or more consecutive years may indicate that the company is going through financial distress. Similarly, considerable increases in the value of assets may mean that the company is implementing an expansion or acquisition strategy, potentially making the company attractive to investors.

Common-size financial statements facilitate the analysis of financial performance by converting each element of the statements to a percentage. This makes it easier to compare figures from one period to the next, compare departments within an organization, and compare the firm to other companies of any size as well as industry averages. On the income statement, analysts can see how much of sales revenue is spent on each type of expense.

The firm did issue additional stock and showed an increase in retained earnings, both totaling a $10,000 increase in equity. However, the equity increase was much smaller than the total increase in liabilities of $40,000. The remainder of that increase is seen in the 5 percent increase in current liabilities. Vertical Common Size Analysis is a method where each line item on a company’s financial statement is listed as the percentage of a single, reference item.

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In such analysis, revenues, expenses, assets, liabilities, and equity are often expressed in actual dollar amounts. For each line item on this sample income statement, we’ve shown the percentage that it makes up of total revenue. If you just looked at numbers, it might seem like this company did better in 2022 because sales increased from $500,000 to $600,000. However, net income only accounted for 10% of 2022 revenue, whereas net income accounted for more than a quarter of 2021 revenue. The company should look for ways to cut costs and increase sales in order to boost profitability. This common size income statement analysis is done on both a vertical and horizontal basis.

It’s also possible to use total liabilities to indicate where a company’s obligations lie and whether it’s being conservative or risky in managing its debts. As we can see from the above chart, using common size analysis allows investors to identify sharp changes in their income statements or balance sheet. The drastic changes become much clearer when comparing financials over longer periods. Recall that a key benefit of common-size analysis is comparing the firm’s performance to the industry.

Limitations of Common Size Analysis

By comparing these percentage figures, you can identify patterns and trends that wouldn’t be visible in the raw financial statements. One of the benefits of using common size analysis is that it allows investors to identify large changes in a company’s financial statements. It mainly applies when the financials are compared over a period of two or three years.

The balance sheet equation is assets equals liabilities plus stockholders’ equity. Similarly, combining common size analysis with horizontal or vertical analysis allows for a deeper dive into specific items of the income statement, balance sheet or cash flow statement. The first step in conducting common size analysis is determining which financial statements are most relevant.

They can see this breakdown for each firm and compare how different firms function in terms of expenses, proportionally. They can also look at the percentage for each expense over time to see if they are spending more or less on certain areas of the business, such as research and development. On the balance sheet, analysts commonly look to see the percentage of debt and equity to determine capital structure. They can also quickly see the percentage of current versus noncurrent assets and liabilities.

Common Size Analysis versus Other Financial Analysis Methods

A deeper dive would require looking at longer periods, such as three to five years, to detect trends. Those longer snapshots can tell you if the company is going through some financial struggles or a rare event. For example, any discernable movements in the income statement can help investors decide whether to invest in Square. Look at the lack of R&D for the last two years, which is surprising, also notice that both costs of goods sold and administration costs have all remained the same over the four years.

The current assets formula determines that the “total current assets,” which are the total of all assets that can be converted to cash within one year, makes up 37% of the company’s total assets. In contrast, current liabilities, which are debts due within one year, make up only 30% of the company’s total assets. You can use it to see how your business stacks up using excel for small business accounting percentage-wise with another business, even if that business is substantially larger. Debt issuance is another important figure in proportion to the amount of annual sales it helps to generate.

The cash flow statement provides an overview of the firm’s sources and uses of cash. The cash flow statement is divided among cash flows from operations, cash flows from investing, and cash flows from financing. Each section provides additional information about the sources and uses of cash in each business activity. While distinct in its approach, common size analysis isn’t mutually exclusive with other financial analysis methods. In fact, it can be beneficial to use common size analysis alongside these other techniques for a more complete view of a company’s financial situation. Applying common size analysis in the context of CSR (Corporate Social Responsibility) and sustainability involves analyzing the financial implications of a company’s initiatives these areas.