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A common size financial statement is document created in order to make it easier to compare various financial accounts. This is achieved by stating figures as percentages rather than raw numbers. The baseline used for the percentage will depend on the type of financial statement being assessed.
The two most common areas for using a common size financial statement are on income statements and balance sheets. With income statements, each item is listed as a percentage of total revenue. With balance sheets, each item is listed as a percentage of total assets.
To give a very simplified example, one company may have revenue of $100,000 (USD), costs of $75,000 and thus, profits of $25,000. A smaller company may have revenue of $20,000, costs of $5,000 and thus, profits of $15,000. At first glance, the larger company appears to be doing better as it is making a larger profit. However, a common sized financial statement comparing the two companies will show that the smaller company actually was more successful.
In a common size financial statement, each company's figures would be restated in comparison to its revenue. This means the first company would have revenue at 100%, costs at 75% and profit at 25%. The second company would have revenue at 100%, costs at 25% and profit at 75%. This method makes it easier to see that the second company is proportionally more profitable or has done a better job of keeping costs under control. Which company's performance is better is still down to the attitude of the analyst, but using the common size financial statement makes it easier to compare the various elements of a company's business.
There are some potential drawbacks to using a common size financial statement. One is that it can give the appearance of making a fairer comparison between different companies, but it still is subject to the normal limitations of such comparisons. This includes companies using different accounting periods and companies using different accounting methods. There will also be problems in comparing companies from different industries as what is considered a good ratio between different items on the financial statement may vary. For example, a candy manufacturer would usually be expected to have a lower revenue-to-costs margin than a luxury car manufacturer, instead making its profits through volume.
The common size financial statement is not used solely for comparing companies. It could instead be used for accounts from the same company at different times. This can be usual for analyzing a company that has gone through rapid growth. It makes it easier to highlight problems, such as a company increasing turnover and profits, but experiencing a drop in efficiency in the way it uses its assets.
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