Common-size Income Statement and Balance Sheet

What is income statement and balance sheet?An income statement or profit and loss account (also referred to as a profit and loss statement (P&L), statement of profit or loss, revenue statement, statement of financial performance, earnings statement, operating statement, or statement of operations) is one of the financial statements of a company and shows the company’s revenues and expenses during a particular period.”

A balance sheet is a financial statement that shows a company's assets, liabilities and shareholders' equity at a specific point in time.

Common-size statement The Common-size statement is the statements in

which amounts of individual items of the income statement and balance sheet are recorded and are further converted into a percentage to a common base

The Common-size income statement is an income statement in which each amount is expressed as a percentage of the revenue. It also allows determining how the various components of the income statement affect a company's profit.

A Common-size balance sheet is a balance sheet in which each amount is expressed as a relative percentage of total assets, total liabilities, and equity accounts. It is generally provided as a comparison against previous time periods.

Advantages of common-size statement

It becomes easy to compare companies as the size does not matters i.e. cross-sectional analysis

It helps in time-series analysis It also highlights the difference in corporate

strategies The purpose of common-size financial statements

is to remove those financial differences between companies that have nothing to do with their primary operations

Disadvantages of common-size statement

Common-size becomes useless if consistency is not maintained in accounting policies, concepts, and conventions.

A Common-size is based on historical data, therefore, it does not recognize changes in price level.

Window dressing is very common in the financial statement. The Common-size statement does not address the issue of window dressing.

The Common-size statement does not give importance to qualitative elements of the firm.

The Common-size statement does not ascertain the Current Ratio, Liquid Ratio, Debt-Equity Capital Ratio, Capital Gearing Ratio etc. which are very useful in testing liquidity and solvency position of a firm.

Financial statement analysis

“Financial statement analysis (or financial analysis) is the process of reviewing and analyzing a company's financial statements to make better economic decisions. These statements include the income statement, balance sheet, statement of cash flows, and a statement of changes in equity. Financial statement analysis is a method or process involving specific techniques for evaluating risks, performance, financial health, and future prospects of an organization.”(White, Gerald I.; Sondhi, Ashwinpaul; Fried, Dov (1998)).

Process of Financial

Statement Analysis Articulate the purpose and context of the analysis.

Collect input data. Process data. Analyze/interpret the processed data Develop and communicate conclusions and

recommendations (e.g., with an analysis report). Follow-up”

Tools of Financial statement analysis

Ratio analysis Common-size analysis Comparative analysis Trend analysis Use of graph Regression analysis

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