Financial analysts have a variety of ways of sizing up a company’s worth. Ratio analysis is commonly employed. However, sometimes, analysts will use a variation of ratio analysis known as common size statements.
This form of analysis is unique because it evaluates all the financial statement components. Every item in a statement is in the form of a percentage of the largest item in the statement. This is helpful when analysts want to focus on the relationship of all the statement components.
In addition, it is a valuable tool for comparing two different years of the company’s statements or when two companies of varying size are compared.When comparing different size companies, it is easy for the large variations in dollar amounts to mask the differences in the relationship of the income statement components.
A variation of this method can be used taking the financial statements of a selected prior year as the base and then determining the components of all future years as percentages of each component in the base year.
The common size statement method is commonly employed with the income statements and the balance sheet. The largest item listed on the income statement is sales. Therefore, on a common size statement, all items are converted as percentages of sales. The largest item listed on the balance sheet is total assets or total liabilities plus stockholders’ equity. Therefore, on a common size statement, all items are converted as percentages of total assets.