A common size balance sheet expresses financial figures as a percentage of the total value for a class of financial information, allowing business owners and managers to quickly identify areas of strength or weakness and compare their financial statements with those of competitors.
A common size balance sheet is an alternative form of the traditional balance sheet financial statement. Where a normal balance sheet expresses information as total financial figures for a specific period in time, a common size shows each figure as a percentage of the total value for a class of financial information. For example, if a company lists $1,000 US dollars (USD) in accounts receivable and current assets out of the total balance of $8,000 USD, the common size statement would report accounts receivable as 12.5 percent (1,000 / 8,000). Each section of the balance sheet (assets, liabilities, and owner’s equity or retained earnings) is presented in this way.
Balance sheets are generally divided into the aforementioned sections. Each section will include a total figure so that managers can determine the amount of assets, liabilities and equity in their respective companies. Using the figures above, suppose the following appears on a balance sheet: $1,200 in cash, $1,000 in accounts receivable, $5,000 in inventory, and $800 in marketable securities. The common-size balance sheet would show this information as 15 percent cash, 12.5 percent accounts receivable, 62.5 percent inventory, and 10 percent marketable securities, for a total of 100 percent.
Creating a common size balance sheet can help business owners and managers spend less time reviewing their companies’ financial information. While it’s important to know the full dollar value of items, representing it as a percentage allows owners and managers to figure out where the business has the most cash. For example, large amounts of inventory may indicate lower cash balances. Higher accounts receivable may represent lower cash and inventory balances as companies are selling more goods on account rather than cash sales. Bottoms can also tell similar stories. Significant increases in accounts payable, lines of credit, or other short-term notes payable may indicate that a company needs external financing for its operations. This situation can create difficult future cash flows and other business situations for years to come.
The size balance sheet also allows business owners and managers to review their long-term assets, long-term mortgages or notes, and equity information. While these accounts may not necessarily be a focus for short-term purposes, a significant increase or decrease in these items may be cause for concern in a company. In addition, common-size financial statements allow owners and managers the ability to compare their companies’ financial statements with those of a competitor. By presenting both statements in percentage form, the comparison can quickly pinpoint which company is weaker or stronger in certain areas.
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