Difference Between Comparative Financial Statement and Common Size Financial Statement
However, the net income has witnessed a slight improvement during the same period. An analyst can further deep dive to determine the reason behind the same to make a more meaningful insight. The ratios that involve net worth—return-on-net-worth and total debt—are negative for Alice, because she has negative net worth, as her debts are larger than her assets. She can see how much larger her debt is than her assets by looking at her debt-to-assets ratio. Although she has a lot of debt (relative to assets and to net worth), she can earn enough income to cover its cost or interest expense, as shown by the interest coverage ratio.
Many of her living expenses have remained consistent; rent and entertainment have increased. Interest expense on her car loan has increased, but since she has paid off her student loan, that interest expense has been eliminated, so her total interest expense has decreased. Overall, her net income, or personal profit, what she clears after covering her living expenses, has almost doubled. Looking at the ratios, it is even more apparent how much—and how subtle—a burden Alice’s debt is. In addition to giving her negative net worth, it keeps her from increasing her assets and creating positive net worth—and potentially more income—by obligating her to use up her cash flows.
Common size balance sheets are used by internal and external analysts and are not a reporting requirement of generally accepted accounting principles (GAAP). The balance sheet provides a snapshot overview of the firm’s assets, liabilities, and shareholders’ equity for the reporting period. A common size balance sheet is set up with the same logic as the common size income statement.
What are Comparative Financial Statements?
- A common size balance sheet is set up with the same logic as the common size income statement.
- Financial statements are essential tools for analyzing a company’s financial performance and position.
- One of the best examples of a common size financial statement is to take a look at the sales revenue on an income statement.
In addition, the statement consists of the financial data from multiple periods in side-by-side columns. By looking at this common size income statement, we can see that the company spent 10% of revenues on research and development and 3% on advertising. In financial statement analysis, it is used to compare companies that operate in the same or different industries or to compare the performance of the same company over different time periods. First, they only provide a snapshot of a company’s financial situation at a specific point in time and do not provide any information on trends or changes over time.
Comparisons over Time
Moreover, companies can use this statement to understand which business aspects require improvements. When comparing any two common size ratios, it is important to make sure that they are computed by using the same base figure. For example, large drops in the company’s profits in two or more consecutive years may indicate that the company is going through financial distress. Similarly, considerable increases in the value of assets may mean that the company is implementing an expansion or acquisition strategy, potentially making the company attractive to investors.
How This Differs From Regular Financial Statements
This is why the common size income statement defines all items as a percentage of sales. The term “common size” is most often used when analyzing elements of the income statement, but the balance sheet and the cash flow statement can also be expressed as a common size statement. A common size financial statement displays items as a percentage of a common base figure, total sales revenue, for example. This type of financial statement allows for easy analysis between companies, or between periods, for the same company. However, if the companies use different accounting methods, any comparison may not be accurate.
Any ratio shows the relative size of the two items compared, just as a fraction compares the numerator to the denominator or a percentage compares a part to the whole. The percentages difference between comparative and common size statement on the common-size statements are ratios, although they only compare items within a financial statement. For example, you can see how much debt you have just by looking at your total liabilities, but how can you tell if you can afford the debt you have? That depends on the income you have to meet your interest and repayment obligations, or the assets you could use (sell) to meet those obligations. Financial statements are valuable summaries of financial activities because they can organize information and make it easier and clearer to see and therefore to understand. Each one—the income statement, cash flow statement, and balance sheet—conveys a different aspect of the financial picture; put together, the picture is pretty complete.
