What are common-size financial statements and how do I use them for analysis?
My CFA Level I prep course mentions common-size statements as a key tool for financial analysis, but I'm not sure how to construct them or what insights they provide that raw financial statements don't.
Common-size statements express every line item as a percentage of a base figure, making it easy to compare companies of different sizes and spot trends over time.
Vertical Analysis (Common-Size)
- Income Statement: Every item as a % of revenue
- Balance Sheet: Every item as a % of total assets
Example -- Pinecrest Manufacturing vs. Lakeshore Industries:
| Income Statement Item | Pinecrest | Lakeshore |
|---|---|---|
| Revenue | 100% | 100% |
| COGS | 62% | 71% |
| Gross Profit | 38% | 29% |
| SG&A | 18% | 14% |
| Operating Income | 20% | 15% |
| Net Income | 12% | 9% |
Even though Lakeshore has 3x Pinecrest's revenue in absolute dollars, the common-size analysis reveals Pinecrest has superior margins at every level.
Horizontal Analysis (Trend)
Expresses each item as a percentage of its base-year value:
| Item | Year 1 (Base) | Year 2 | Year 3 |
|---|---|---|---|
| Revenue | 100% | 112% | 128% |
| COGS | 100% | 115% | 135% |
| SG&A | 100% | 108% | 118% |
Here, COGS is growing faster than revenue (135% vs 128%), indicating margin compression. SG&A is growing slower, suggesting operational leverage.
Balance Sheet Common-Size Example:
| Item | Company A | Company B |
|---|---|---|
| Cash | 8% | 22% |
| Receivables | 15% | 10% |
| Inventory | 25% | 5% |
| PP&E | 40% | 18% |
| Intangibles | 12% | 45% |
Company A is asset-heavy (manufacturing), while Company B is intangible-heavy (technology or pharma).
Key Insights from Common-Size Analysis:
- Cross-company comparison eliminates size bias
- Trend identification reveals margin expansion or compression
- Capital structure shifts become visible on common-size balance sheets
- Red flags like suddenly higher inventory or receivables percentages stand out
Exam Tip: Be ready to calculate common-size ratios from raw numbers and interpret what changes mean for the company's financial health.
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