Lesson 6 - Intermediate Accounting Course 

6. Common Size Financial Statements: Why They Matter

Common size financial statements are a valuable tool for analyzing and comparing companies, regardless of their size. By expressing each line item as a percentage of a key figure (such as total revenue for the income statement or total assets for the balance sheet), these statements help identify financial trends, evaluate performance, and compare companies across industries.

1. What Are Common Size Financial Statements?

A common size financial statement converts raw financial data into percentages, making it easier to analyze financial performance over time or compare different companies.

There are three main types:

• Common Size Income Statement (expresses each item as a percentage of total revenue).

• Common Size Balance Sheet (expresses each item as a percentage of total assets).

• Common Size Cash Flow Statement (less common, but expresses items as a percentage of total cash inflows).

This approach helps in benchmarking, identifying trends, and understanding the relative importance of different financial elements.

2. Common Size Income Statement

A common size income statement expresses each item as a percentage of total revenue.

Example Format:

By converting raw figures into percentages, you can:
✔ Compare profitability trends over time.
✔ See if expenses are increasing or decreasing relative to sales.
✔ Benchmark against industry averages or competitors.

Key Insights from a Common Size Income Statement

✅ A higher gross margin (Gross Profit ÷ Revenue) suggests strong pricing power or efficient production.
✅ A lower operating expense percentage means better cost control.
✅ A higher net profit margin (Net Income ÷ Revenue) indicates strong profitability.

⚠ Red Flags:
✖ Increasing costs as a percentage of sales could indicate inefficiencies.
✖ Declining profit margins over time suggest pricing pressure or rising costs.

3. Common Size Balance Sheet

A common size balance sheet expresses each item as a percentage of total assets.

Example Format:

By converting numbers into percentages, you can:
✔ Identify how a company finances its assets (through debt or equity).
✔ Assess liquidity by looking at current assets relative to total assets.
✔ Compare capital structure across companies of different sizes.

Key Insights from a Common Size Balance Sheet

✅ A higher percentage of current assets suggests strong short-term liquidity.
✅ A lower debt percentage (Total Liabilities ÷ Total Assets) means lower financial risk.
✅ A higher shareholders’ equity percentage shows strong financial stability.

⚠ Red Flags:
✖ A high percentage of debt (especially long-term debt) may indicate financial risk.
✖ Low cash levels could signal liquidity problems.
✖ High accounts receivable might suggest collection issues.

4. Benefits of Common Size Statements

1️⃣ Easier Comparison Across Companies

• Two companies with different revenue sizes can be compared based on percentage values rather than raw numbers.

2️⃣ Identifying Trends Over Time

• By analyzing several years of common size statements, you can see if expenses, debt levels, or profitability are improving or worsening.

3️⃣ Industry Benchmarking

• You can compare a company's percentages with industry averages to see if it's performing above or below its competitors.

4️⃣ Better Decision-Making

• Investors and managers use common size statements to make informed decisions about profitability, liquidity, and financial structure.

5. Final Thoughts

Common size financial statements are a powerful tool for financial analysis. By converting raw financial data into percentages, they make it easier to compare companies, track performance over time, and identify potential strengths and weaknesses.

When analyzing a company's financial health, using common size income statements and balance sheets alongside traditional financial ratios provides a more complete picture of its profitability, liquidity, and financial structure.