Breaking Down Common-Size Financial Statements
Financial Statement in Common Sizing: Meaning and Illustration
Common-size financial statements are a game-changer for business analysts. They transform raw financial data into a more readable, comparable format, so you can easily compare companies of different sizes or sectors, or track progress across time.
What Are Common-Size Financial Statements?
These nifty tools take the traditional dollar values on a financial statement and convert them into percentages of a specific base figure. This allows for a simpler, apples-to-apples analysis. For example, a common-size balance sheet could reveal that one company's total assets consist of 20% cash while another company's balance sheet is 25% cash.
Key Insights
- Easy Comparison: Common-size statements shift from absolute dollar amounts to percentages of a common base figure, helping analysts make fair comparisons.
- Reducing Bias: By removing scale effects, it’s easier to identify the essence of financial performance without bias.
- Popular Components: The income statement, balance sheet, and cash flow statement are the common components you'll come across in common-size statements.
Digging Deeper
While many firms avoid common-size formatting, analysts can derive immense benefits by reformatting statements. This helps when comparing multiple companies of varying sizes or sectors. Besides, it allows you to study a company's dynamics over different periods more effectively, like understanding the percentage of sales that go towards the cost of goods sold and how that proportion changes over time.
Common-Size Secrets
- Standardization: All figures in common-size statements are reduced to a comparable base figure like a percentage of sales or assets.
- Affinity for Income Statements: While all statements can be expressed as common-size, the income statement is most commonly analyzed in this format.
Fast Fact
Common-size financial statements aid in determining what factors drive a company's profitability and help compare a company with similar businesses.
Breaking Down Common-Size Statements
Common-Size Balance Sheet
The balance sheet offers an overview of a company's assets, liabilities, and equity for a specific period. A common-size balance sheet operates much like the common-size income statement, but instead of expressing everything as a percentage of sales, it analyzes items as percentages of total assets for the same period.
Common-Size Cash Flow Statement
The cash flow statement displays a firm's sources and uses of cash during the reporting period, which is divided into cash flows from operations, investing, and financing. A common-size cash flow statement can be presented as percentages of total cash flow or as percentages of operational cash flow, investing cash flow, and financing cash flow.
Common-Size Income Statement
The income statement showcases a company's revenue, expenses, and net income during the reporting period. The common-size format defines each item as a percentage of total sales, helping analysts identify trends in profitability, operational costs, and resource allocation.
Real-world Example of Common-Size Income Statement
Let's say a company has a simple income statement with gross sales of $100,000, cost of goods sold of $50,000, taxes of $1,000, and net income of $49,000. The common-size statement would look like this:
- Gross Sales: 100%
- Cost of Goods Sold: 50%
- Taxes: 1%
- Net Income: 49%
- The common-size income statement, while analyzing a company's revenue, expenses, and net income, defines each item as a percentage of total sales, aiding in identifying trends in profitability, operational costs, and resource allocation.
- In the context of digital finance, common-size financial statements can be particularly useful when analyzing token sales, initial coin offerings (ICOs), and initial exchange offerings (IEOs) by comparing their financial performance with other businesses in the decentralized finance (DeFi) sector, or over time.
- A comprehensive comparison of investing opportunities in DeFi can be achieved by standardizing ICO and IEO financial data into common-size statements, allowing investors to recognize patterns in return on investment (ROI) and key performance indicators (KPIs) when trading digital tokens.
- As the finance industry evolves towards more decentralized models, mastering the use of common-size financial statements is essential for business analysts, investors, and entrepreneurs involved in the trading, investing, and developing of DeFi projects.
