What is Common Size Balance Sheet Analysis?
Common size balance sheet refers to percentage analysis of balance sheet items on the basis of the common figure as each item is presented as the percentage which is easy to compare, like each asset is shown as a percentage of total assets and each liability is shown as a percentage of total liabilities and stakeholder equity as a percentage of total stakeholder’s equity.
It is convenient to build a common size statementCommon Size StatementIn a common size financial statement, each element of financial statements are shown as a percentage of another item. For instance, in case of the Balance Sheet assets, liabilities, and share capital are represented as a percentage of total assets. In the case of Income Statement, each element of income and expenditure is defined as a percentage of the total sales. balance sheet because it helps in building trend lines to discover the patterns over a specific period of time. In short, it is not just an upgraded variety of the balance sheet per se. Still, it also captures each single line item as a percentage of total assets, total liabilities, and total equity besides the usual numeric value.
Examples of Common Size Balance Sheet Analysis
Let us take the example of Apple Inc. to see the trend in the financials of the last three years.
All amount in Millions
For instance, it can be seen that there is a relative decrease in the long term investments from 2016 to 2018, while the current liabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc. have witnessed an uptrend during the same period. An analyst can further deep dive to determine the reason behind the same to make a more meaningful insight.
Detail screenshot of the excel template with formula
Common Size of Colgate’s Balance Sheet
- Cash and Cash equivalentsCash And Cash EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation. Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. as a percentage of total assets increased substantially from 5.6% in 2008 to 8.1% in 2014.
- Receivables percentage decreased from 16.6% in 2007 to 11.9% in 2015.
- Inventories percentage decreased from 11.6% to 9.9% overall.
- Other current assets percentage increased from 3.3% to 6.7% of the total assets over the last 9 years.
- On the liabilities side, Accounts payableAccounts PayableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period. currently stands at 9.3% of the total assets.
- There has been a significant jump in the Long Term DebtTerm DebtLong-term debt is the debt taken by the company that gets due or is payable after one year on the date of the balance sheet. It is recorded on the liabilities side of the company's balance sheet as the non-current liability. to 52,4% in 2015.
- Non controlling interests has also increased over 9 years and is now at 2.1%
- It aids the reader of the statement to understand clearly the ratio or percentage of each item in the statement as a percentage of total assets of the company.
- It aids a user in determining the trend related to the percentage share of each item on the asset side and percentage share of each item on the liability side.
- A financial user can also use it to compare the financial performances of different entities at a glance since each item is expressed in terms of percentage of total assets, and the user can determine any required ratio quite easily.
- A common size balance sheet is regarded as impractical since there is no approved standard proportion of each item to the total asset.
- In case the balance sheetThe Balance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. of any particular company is not prepared year after year consistently. It will be misleading to perform any comparative study of the common size statement balance sheet.
Limitations of Common Size Balance Sheet Analysis
- It does not aid in making decisions because there isn’t any approved standard proportion regarding the composition of assets, liabilities, etc.
- If there is inconsistency in preparing the financial statements due to changes in accounting principlesAccounting PrinciplesAccounting principles are the set guidelines and rules issued by accounting standards like GAAP and IFRS for the companies to follow while recording and presenting the financial information in the books of accounts., concepts, conventions, then a common size balance sheet becomes meaningless.
- It does not convey proper records during times of seasonal fluctuations in various components of assets, liabilities, etc. Therefore, it fails to provide the actual information to the financial users of the statements.
- One can’t ignore the ill effects of window dressingWindow DressingWindow dressing in accounting refers to the intentional manipulation of financial statements by company management in order to present a more favourable picture of the company to users of the financial statement before it is released to the public. in financial statements, and sadly a standard size balance sheet fails to identify the same to provide the real positions of assets, liabilities, etc.
- It fails to identify the qualitative elements while gauging the performance of a company, although it is not a good practice to ignore the same. Examples of qualitative elements may include customer relations, quality of works, etc.
- They can’t measure the solvencySolvencySolvency of a company means its ability to meet the long term financial commitments, continue its operation in the foreseeable future and achieve long term growth. It indicates that the entity will conduct its business with ease. and liquidity position of a company. It merely measures the percentage increase or decrease in various components of assets, liabilities, etc. In other words, a common size balance can’t be used to determine the debt-equity ratioDebt-equity RatioThe debt to equity ratio is a representation of the company's capital structure that determines the proportion of external liabilities to the shareholders' equity. It helps the investors determine the organization's leverage position and risk level. , capital ratio, current ratioCurrent RatioThe current ratio is a liquidity ratio that measures how efficiently a company can repay it' short-term loans within a year. Current ratio = current assets/current liabilities , liquidity ratio, capital gearing ratioCapital Gearing RatioCapital Gearing, also called Financial Leverage, is the level of debt that a Company utilizes for obtaining assets. It is determined as the ratio of Total Equity to Total Debt. , etc. which are usually applied in ascertaining the solvency and liquidity position of a companyLiquidity Position Of A CompanyLiquidity shows the ease of converting the assets or the securities of the company into the cash. Liquidity is the ability of the firm to pay off the current liabilities with the current assets it possesses..
In conclusion, it can be said that a common size balance sheet facilitates an easy comparison of the year-on-year performance of the same company or comparison of different companies of varied sizes. To elaborate, not only can a user effortlessly see how well the capital structure of a company is allocated, but they can also compare those percentages to other periods in time or to other companies. It also enables an analyst to compare companies of varied sizes irrespective of their size difference, which is in-built in the raw data.
This article has been a guide to Common Size Balance Sheet Analysis. Here we discuss Common Size Balance Sheet Format along with examples of Apple and Colgate. You may learn more about from the following articles –