Question

Explain how to create a common size income statement and a common size balance sheet. Provide at least three reasons why analysts find the creation of common size statements to be a useful practice.

Answer 1

Common size statement is a representation of each line item in a financial statement as a percentage of a base figure within the statement.

For Income statement base figure is Sales, Formula : % of base = (Line item figure / Sales) * 100

For balance sheet base figure is Total Assets, Formula : % of base = (Line item figure / Total Assets) * 100 .

Why common size statements are useful

1) Common size statement allows investors to identify drastic changes in a company’s financial statement over a period of two or more years.

2) Because of Common size statement one can compare the company with its competitors irrespective of different size of the competitor.

3) The common size percentages allows investors to understand how each component affects the financial position of the company.