WHY?? How much revenue did the company book in order to achieve those earnings? How much did competitors of a similar size earn? How much did the company earn last year?
WHAT?? Common size analysis is one tool to compare companies across time and with other companies. Three Types: Vertical Common Size Income Statements Horizontal Common Size Income Statements Common Size Balance Sheets
Comparing Performance of Companies To compare companies of different sizes Helps in benchmarking Industry comparison Quick overview of where the firm stands in the industry
A Case For example This comparison is somewhat misleading because of the different size of the two companies.
Alternative For better comparison, the net income figures can be expressed as a percentage of the sales revenues of each company
Basic Concepts Generally Net Sales are taken as base in the income statement Gross sales are not taken Excise duty is deducted from gross sales, net sales gives the right picture. Common size analysis helps us to calculate the expenses as a percentage of revenue. Total assets=Total liabilities is taken as the base in Balance sheet.
Common Size Income Statement
Analysis Material cost has increased by 6%. Though the figure has doubled. It is because of inflation or inadequate use of resources. Income from other sources has initiated this year. PBDIT has decreased by 3% because of increase in material cost. Exceptional expenses zeroed this year as there was no expenditure on sports infrastructure. Deferred tax has decreased because of cancellation of revaluation of foreign currency loans and decrease in difference between book and tax depreciation.
Common Size Balance Sheet
Analysis Proportion of share capital and reserves and surplus has reduced due to an increase in unsecured loans. Investments has increased drastically. Unsecured loans has seen a significant change of 9%. Cash and bank balances has increased. This shows that the company is improving its liquidity position. Loans and advances has drastically decreased. Total assets have increased due to increase in investments.
Limitations Different accounting principles may be used by different firms. So adjustment need to be made. Firms may use different accounting calenders. Diversified companies are difficult to classify for comparison purposes. Financial data is not adjusted for price changes or inflation/deflation. Jugdement cannot be based on this analysis only. Other sources of data should also be analyzed.