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1.
If investors want to compare the financial statements of different organizations, then there needs to
be some commonality so that two totally different businesses from different industries even from
different countries can be compared.
This is important because when you want to invest in companies, you need higher returns and
therefore investor needs to understand and compare the profit, losses, size, growth and other
important parameters of the companies.
One cannot compare financial statements of different organizations directly as that can lead to
incorrect judgements due to difference in currency values, size of company. Therefore common size
analysis is used for decision making were common size financial statements are preared. In this, all
financial statements are reported in form of percentage.
Base figure is taken which is divided with all items in the statement and are reported as percentage
of gross sales.
Reasons to use Common Size analysis are:
1. Comparision can be done between different periods.
2. Comparison can be done among competitors
3. Comparing financial statements with global companies where currency is different
Towo types of common size analysis are:
1. Horizontal Common Size Analysis
It uses one type of financial statement at a time. It compares several consecutive years, usually 3 and
more to measure long-term trends in the organizations growth and performance.
Baseline year is compared with following years and we can see the growth pattern.
Current
Previous Year Percentage ( Year Percentage
2016 2016 ) 2017 ( 2017 )
Net sales 975 100.00% 1200 123.08%
Less: Cost of goods sold 438.75 100.00% 600 136.75%
Gross profit 536.25 100.00% 600 111.89%
Less: Selling and distribution
Exp. 140 100.00% 180 128.57%
Operating Profit 396 100.00% 420 106.06%
Less: Interest expenses 101 100.00% 126 124.75%
Earnings before taxes 295 100.00% 294 99.66%
Less: Taxes 118 100.00% 117.6 99.66%
Earnings after taxes 177 100.00% 176.4 99.66%
We perform the calculations as follows:
1. ((Net Sales in 2017) / (Net Sales in 2016) )* 100 = 123%
2. ((Cost of Goods Sold in 2017) / (Cost of Goods Sold in 2016) )* 100 = 136%
3. ((Gross Profit in 2017) / (Gross Profit in 2016) )* 100 = 111.8%
and so on.
In this, we can observe that Net Sales have drastically growth from 975 to 1200 which means net
sales has grown to 123% in 1 year. Likewise, COGS has growth to 136%, Gross Profit has grown to
111%, Operating Profit has grown to 106%. The only components which displayed minuscule
reduction are Earnings before taxes, Less: Taxes, Earnings after taxes.
2. Vertical Common Size Analysis
It refers to propotional analysis of the financial statements. In Vertical common size analysis,
each item is recorded as percentage of base item which is the gross sales ( whenever Income
Statement is taken ) and when Balance sheet of the organization is undertaken, total Assets is
taken as base and is divided with each of the items in the financial statement.
In the question below,since it is an income statement, we have taken Net Sales as the Base
value and each of the items such as COGS, Gross profit, Less: Selling and Distribution
expenditure, operating profit, all are divided by the Net Sales to calculate the percentage.
Vertical Common Size Analysis of Income Statement 1: