Financial statements are reports of a company’s financial position and performance. They provide an overview of a company’s operations over a specific period. Consequently, it allows stakeholders to analyze the company. However, these statements come as a part of a standard package stemming from accounting practices and principles. For some stakeholders, the primary financial statements may not provide sufficient information.
Therefore, stakeholders use alternative formats to the standard version. The primary objective is to help analyze the company and its operations better. One such format commonly used for analysis is the common-sized financial statements.
What are Common-Sized Financial Statements?
Common-size financial statements are a type of analysis report that standardizes financial information. It uses a percentage format based on a common base item, which may differ based on several factors. This format makes it easier to compare financial information across companies, periods, or company sizes. Similarly, it allows stakeholders to remove the effect of absolute size differences.
Common-sized financial statements may include the balance sheet, income statement, and cash flow statement. The basic premise of this format is to choose a base amount and use it to calculate the ratios for each line item in these statements. Usually, it also involves multiplying that ratio by 100 to get a percentage. Once stakeholders get this percentage, it is easier to compare it across various areas.
What is a Common-Sized Balance Sheet?
A common-sized balance sheet presents a company's balance sheet in a standardized format. As mentioned above, it uses a percentage-based format to present every line item as a ratio. In this case, the base is the total assets of a company. The objective of a common-sized balance sheet is to make it easier to compare a company’s financial position with other companies or with itself over several periods.
Common-sized balance sheets are helpful in financial statement analysis. They help compare the relative size of each line item across different companies or periods. Likewise, they provide a more detailed picture of a company's financial position. Common-sized balance sheets also show the relative proportion of each asset, liability, and equity item. For many stakeholders, this format can be significantly helpful.
What is the difference between Horizontal and Vertical Common-Sized Financial Statements?
Common-sized financial statements may come in two types, horizontal and vertical. Given below is an explanation of what each of these includes.
Horizontal Common-Sized
Horizontal common-sized financial statements help with yearly comparisons. Companies use this format for income statements, where tracking how income and expenses have changed is crucial. Usually, horizontal common-size analysis involves using the previous year's figures as the base for each item. It differs from the standard format, where one base is used for all figures.
Vertical Common-Sized
Vertical common-sized financial statements are helpful when stakeholders compare several companies. This format helps compare figures based on a common base item. For example, stakeholders may use revenues as this base for the income statement. This format helps eliminate size differences between companies for better comparisons.
Conclusion
Common-sized financial statements refer to a different format used for analyzing companies. It converts a company's financial statements to a percentage-based format. Similarly, it might be vertical or horizontal based on the needs of stakeholders and the company. The common-sized financial statements use a standard format to facilitate better comparisons.
Originally Published Here: Common-Size Financial Statements and Balance Sheets
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