What is Common Size Balance Sheet Analysis?
The term “common size balance sheet” refers to the presentation of all the line items in a balance sheet in a separate column in the form of relative percentages of total assets primarily. This technique is convenient for comparison of the number of assets, liabilities and equity among different companies, especially when they are used for an acquisition analysis.
It is convenient to build a common size 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, but 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 Format
Let us take the example of Apple Inc. common size balance sheet format to see the trend in the financials of the last three years.
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For instance, it can be seen that there is a relative decrease in the long term investments from 2016 to 2018, while the current liabilities has 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 equivalents 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 payable currently stands at 9.3% of the total assets.
- There has been a significant jump in the Long Term Debt to 52,4% in 2015.
- Non controlling interests has also increased over the period of 9 years and is now at 2.1%
Advantages of Common Size Balance Sheet analysis
The advantages of a common size balance sheet format are:
- It aids the reader of the statement to understand clearly the ratio or percentage of each individual item in the statement as a percentage of total assets of the company.
- It aids a user to determine 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.
Disadvantages of Common Size Balance Sheet Analysis
The disadvantages of a common size balance sheet format are:
- 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 sheet of any particular company is not prepared year after year on a consistent basis, then it will be misleading to perform any comparative study of common size statement balance sheet.
Limitations of Common Size Balance Sheet Analysis
The limitations of a common size balance sheet format are:
- 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 principle, concepts, conventions, then a common size balance sheet becomes meaningless.
- A common size balance sheet 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 dressing in financial statements and sadly a common size balance sheet fails to identify the same to provide the real positions of assets, liabilities etc.
- A common size balance sheet 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 solvency and liquidity position of a company. It simply 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, capital ratio, current ratio, liquidity ratio, capital gearing ratio etc. which are usually applied in ascertaining solvency and liquidity position of a company.
In conclusion, it can be said that a common size balance sheet facilitates 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 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 –
- Examples of Accounts Payable Journal Entries
- Current Liabilities Formula | Explanation
- Reading a Balance Sheet
- Examples of Vertical Analysis of Income Statement
- Examples of Income Statement Basics
- Common Size Income Statement
- Vertical Analysis Formula
- What is Classified Balance Sheet?
- Balance Sheet Formulas
- What is the Purpose of Balance Sheet?
- Off-Balance Sheet Items