Monday, January 23, 2012

Common-Size Financial Statements

In common-size statements, balance sheet and income statements items are normalized with respect to a single line item and expressed as proportions of that line item. In the case of balance sheet, total assets is taken as the base and all line items are expressed as a percentage of total assets. In the case of income statement, sales is taken as the base and all line items are expressed as percentage of sales.

Common size ratios are useful to quickly compare two different-size firms. But the more important use of common size statement is in financial modeling. Trends over time within a single firm's balance sheet and income statement structure are determined from common size statements.  These trends will give the basis for estimating percentage of sales consumed by production costs, and amount of short term liabilities employed by the firm etc. These ratios are used in financial modeling to project future financial statements.

Reilly, Frank and Keith Brown, Investment Analysis and Portfolio Management, 7th Edition, Thomson-South Western, 2003, p.323

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