What is the Common Size Statement?
Common Size of financial statements is a technique used to identify where a company has applied its resources and in what proportions those resources are distributed among the various balance sheet and income statement accounts. The analysis determines the relative weight of each account and its share in asset resources or revenue generation.
In the common size, each element of financial statements (Both Income Statement and Balance sheet) are shown as a percentage of another item. The assets, liabilities, and share capital is 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.
There are two types of Common Size Statements – a) Balance Sheet & b) Income Statement
#1 – Common Size Statement of Balance Sheet
As an example of common size, let us take a balance sheet of the Tata group companies as on 30.09.2016.
If we only look at the above balance sheet, it doesn’t make much sense.
Let me convert each and every element of this balance sheet as a percentage of “Total,” which is 119,020 (common size of the balance sheet). Then the balance sheet will appear as follows –
Now have a look at the above balance sheet. Looks much intuitive, right? When we perform a common size, the data provides financial insights.
In this case, for making the common size of the Balance SheetCommon Size Of The Balance SheetThe term "common size balance sheet" refers to a percentage analysis of balance sheet items based on a common figure, with each item presented as an easy-to-compare percentage. For example, each asset is expressed as a percentage of total assets, and each liability is expressed as a percentage of total liabilities., we converted all the elements of the balance sheet as a percentage of the total. –
On a standalone basis, we can derive the following conclusions from the balance sheet:
- Reserves & surplus, which is 58.3%, is the highest portion. The company is having a massive amount of reserves.
- The debt to equity ratioDebt To 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. in this company is (19.6÷1) = 0.33, which is low. That means that the company is not using enough debt. The more debt brings financial leverageFinancial LeverageFinancial Leverage Ratio measures the impact of debt on the Company’s overall profitability. Moreover, high & low ratio implies high & low fixed business investment cost, respectively. and tax savings.
- The majority of reserves and a surplusReserves And A SurplusReserves and Surplus is the amount kept aside from the profits that are to be used either for the business or for the shareholders to pay out dividends. Reserves and surplus is reflected under shareholders funds in the balance sheet. portion is invested in non-current investments.
- Most of the long-term borrowings are invested in fixed assetsInvested In Fixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples..
- The company predominantly invested in Noncurrent investments than current investments.
- The company is a considerable capital intensive Capital IntensiveCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining. company as an investment in non-current assets (Especially fixed assets is very high which is nearly 42.5%)
- Company trade receivables are 0.7%, whereas trade payables are 5.6%. It means that the company is not giving much credit to debtors, whereas it is enjoying the credit period from its creditors.
As seen above, the common size statement can give you a lot of better insights into the financial position of the company than when you look at the same otherwise.
Common Size statements of Balance Sheet Over different periods
In continuation of the above common size example, let us now compare two-year balance sheets of the same company.
Let us convert the same into percentage terms and derive some conclusions.
After the conversion of the two years balance sheets, we can derive that.
- Reserves marginally increased by 2% compared to 2015. It means profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance. must have increased.
- Long-term borrowings have decreased by 1%; this means that some marginal repayments of loans must have happened.
- There is an increase in short-term borrowings by 1.7%.
- Inventory levels remained almost the same.
- There is a marginal increase in trade receivablesIncrease In Trade ReceivablesTrade receivable is the amount owed to the business or company by its customers. It is also known as account receivables and is represented as current liabilities in balance sheet..
- The share capitalShare CapitalShare capital refers to the funds raised by an organization by issuing the company's initial public offerings, common shares or preference stocks to the public. It appears as the owner's or shareholders' equity on the corporate balance sheet's liability side. remained the same, which means there is no fresh issuance of capital.
#2 – Common Size Statement of Income Statement
Let’s go now perform the common size of the Income StatementCommon Size Of The Income StatementCommon Size Income Statement is a Company’s financial statement that presents every listed line item as a percentage of total revenue or sales. Moreover, it helps analyze the contribution of every item towards the profitability of the Company. for different periods and analyze the same on the stand-alone period basis and for different years. Following is the P&L account of a Tata group company.
A plane looking at the above Income Statement might be confusing. So, let’s convert the same as a percentage of sales or Total income from operations. (Common Size of the Income Statement)
The following conclusions can be derived after converting the same as common size financial statements and comparing over different periods.
- There is a reduction in the purchase of finished, semi-finished steel and other products as the percentage fell from 3.3% in Dec 2015 to 1.4% in Dec 2016.
- Raw material consumption at ~23% remains as per the past trend.
- Employee cost reduced from 11% in Dec 2015 to 8.5% in Dec 2016
- Power cost too reduced from 6% to 5% in Dec 2016
- Total expenses reduced considerably from 91.5% in Dec 2015 to 82.2% in Dec 2016
- Income Tax expense increased three times from 1.6% in Dec 2015 to 4.2% in Dec 2016
On a standalone basis (i.e., by analyzing a single period), the following conclusions can be derived.
- Raw material contributes to being a high cost in the process of manufacture, which is nearly 23% of every sale.
- The net profitability margin of Dec 2016 period is 8.5%
- Since PBT is 12.7% and tax expense is 4.2% of sales, the company tax rate is around 30%
- The company has more closing stockMore Closing StockClosing stock or inventory is the amount that a company still has on its hand at the end of a financial period. It may include products getting processed or are produced but not sold. Raw materials, work in progress, and final goods are all included on a broad level. than opening stock as Changes in inventories for Dec 2016 period is negative.
Common Size Statement of Colgate’s Income Statement
- In Colgate, we note that the gross profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. is in the range of 56%-59%.
- Selling General and administrative expensesSelling General And Administrative ExpensesSelling, general and administrative (SG&A) expense includes all the expenses incurred in the selling of the products of the company whether direct or indirect along with the entire general and the administrative expenses during an accounting period under consideration such as advertisement expenses, sales promotion expenses, marketing salaries, etc. decreased from 36.1% in 2007 to 34.1% in the year ending 2015.
- Operating income dropped significantly in 2015.
- Net income decreased substantially to less than 10%.
- Effective tax ratesEffective Tax RatesEffective tax rate determines the average taxation rate for a corporation or an individual. For both, there is a similar formula only with variation in considering variables. The effective tax rate formula for corporation = Total tax expense / EBT jumped to 44% in 2015. Between 2008 to 2014, it was in the range of 32-33%.
Common Size Statement 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. increased from 4.2% in 2007 to 8.1% of the total assets.
- Receivables decreased from 16.6% in 2007 to 11.9% in 2015.
- Inventories decreased from 11.6% to 9.9% overall.
- Other current assets 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 DebtLong Term 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 the period of 9 years and is now at 2.1%
- Profit statements and other financial reports of different companies can be easily compared even though they are of different sizes. For example, the Balance sheet of Apple Inc and Samsung can be easily comparable after converting both into percentage terms.
- Within one company, annual or quarterly changes in the elements can be easily compared. For example, the Income statementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements. of Apple Inc of different years can be comparable if the same is converted into a percentage. It gives a perfect indication of how much sales revenueSales RevenueSales revenue refers to the income generated by any business entity by selling its goods or providing its services during the normal course of its operations. It is reported annually, quarterly or monthly as the case may be in the business entity's income statement/profit & loss account. improved or declined. How much each expense moved. How much depreciation expense increased or decreased.
- Promotes effective management decision making;
This article has been a guide to what is Common Size Statements and its meaning. Here we discuss the common size of balance sheet and income statement along with practical examples of Tata and Colgate. You may learn more about Financial Analysis from the following articles –