What are the advantages and disadvantages of common size statements? (2024)

Common size statements are a way of standardizing financial statements by expressing each item as a percentage of a common base. For example, in a common size income statement, each revenue and expense item is shown as a percentage of total sales. Similarly, in a common size balance sheet, each asset, liability, and equity item is shown as a percentage of total assets. This allows you to compare the relative proportions of different items across companies or periods, regardless of their absolute values.

To prepare common size statements, you need to have the original financial statements of the company or companies you want to compare. Then, you need to divide each item by the common base and multiply by 100 to get the percentage. For example, if a company has sales of $100,000 and cost of goods sold of $60,000, its common size income statement would show sales as 100% and cost of goods sold as 60%. You can use a spreadsheet or a calculator to perform these calculations.

Common size statements offer several advantages for financial analysis and performance evaluation. They enable comparison of the financial performance of different companies or periods, regardless of size or scale, as well as identification of trends and patterns in a company's or industry's financial performance over time. Additionally, common size statements simplify financial statements and make them easier to understand and interpret, allowing you to quickly observe the items with the highest or lowest impact on financial performance.

Common size statements have some disadvantages and limitations that should be taken into account. These include a lack of information about absolute values or growth rates, differences in accounting policies, methods, or standards, and the inability to capture the effects of inflation, exchange rates, or other external factors. For example, you cannot tell how much revenue or profit a company has generated or how fast it has grown using common size statements. Additionally, you may not be able to compare the depreciation or inventory valuation methods of two companies, nor can you adjust for changes in purchasing power or currency value.

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