Common size analysis compares financial statements of companies of different sizes or from different time periods by reducing raw numbers to percentages, allowing for easier comparison. It can be performed on income statements or balance sheets and is best done using benchmarks. The accuracy of the analysis depends on the accounting practices used.
Common size analysis is a method of comparing financial statements of companies of different sizes or financial statements of a company from different time periods. It achieves these comparisons by measuring some part of a company’s financial operations against all operations. By doing this, common size analysis reduces raw numbers to percentages that allow for much easier comparison between companies and over time. This method of analysis can be performed on income statements or balance sheets, but it is only as accurate as the accounting practices used to derive the numbers.
It is difficult to make financial comparisons between companies, even those in the same industry, simply because circumstances between companies can be very different. Similarly, it’s hard to look at the numbers a company produces in a single year and compare it to what it did, say, five years ago, since financial conditions will certainly have changed in that time frame. Fortunately, a common size analysis can be performed, allowing for much more reliable comparisons.
As an example, imagine that a company has total assets that measure $10,000 US dollars (USD). Of that total, you have $2,500 in cash, $3,500 in accounts receivable, and $4,000 in inventory. To represent these different items for common size analysis, they would all be reduced to a percentage of total assets. In other words, cash would be listed at 25 percent, accounts receivable at 35 percent, and inventory at 40 percent.
By using common size analysis, comparisons can be made more easily over time and across the industry. These comparisons are best made using benchmarks. A benchmark could be another company that is performing well in the industry, or if a company wants to measure its performance against its own standards, the benchmark would be a past year in which it performed particularly well. Putting the current numbers against the benchmark would allow the company to see where its operations might be lacking.
A common size analysis can also be done on the liabilities a company has, or it can be done on its balance sheet as a whole. In this way, elements of a company’s operations, such as debt, equity, and cost of goods sold, can be measured against the financial operations as a whole. The only limit to such an analysis is the potential for faulty accounting practices to skew the numbers on which the percentages are based.
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