# The Common-size Financial Statement Analysis (Vertical and Horizontal)

## An introduction to the common-size analysis

Sometimes items on company’s financial statement are being displayed as a percentage of a common figure. This is called common-sized financial statement. It is being done in order to make it easier to analyze a company in dynamics and compare it with other firms, making the comparison more meaningful. Common-size analysis can be applied to all three main statements of a company.

Horizontal financial statement analysis (also referred as trend analysis) is the comparison of company’s financial report information over some periods of time. Applying horizontal analysis to firm’s statements makes it comfortable to estimate its performance over time. Vertical is the analysis of items of the company’s statements when one item is being compared to the base item. While the horizontal analysis aims to estimate the dynamics, vertical is commonly applied for a single period. The reason for performing it is the necessity to estimate the relative proportions of different assets and finance sources elements.

## Balance Sheet as an object of common-size analysis

In balance sheet common-size analysis total assets are usually being set as a common figure. As known from the basic balance sheet equation, total assets equal total liabilities plus shareholders’ equity, thus, these figures are interchangeable. Sometimes analysts also use total liabilities as a common figure, mostly when they need to estimate company’s obligations and firm’s manner of debt management.

Applying common-size analysis to firm’s balance sheet gives us a clear understanding of its capital structure, which can be compared to other firms or some optimal capital structure for the industry. It also allows to estimate whether some of the company’s debts being too high.

Below is an example of simple common-size balance sheet of a company:

It shows common-size information on company’s assets, liabilities and stockholders’ equity over 3 years. Running through this information the analyst can see that company’s long-term debt is around 18-20% of its total assets, and this is a reasonable level. Cash represents around 10% of firm’s assets, and short-term obligations are from 5% to 7%, which is reasonable too. Summing up short-term and long-term obligations and comparing this amount to available cash would show if a firm is dependent on additional financing to pay its debt when due, or it can cover it immediately.

## Income statement as an object of common-size analysis

For the income statement net revenue is usually being set as a common figure, which makes the analysis the same as calculating margins of a firm. Net income margin, gross profit margin, operating income margin are all elements of both profitability ratio analysis and common-size analysis.

Below is an example of firm’s common-size income statement:

We can see that the company has increased its net income margin by nearly 5% in year 2 comparing to year 1, which is a big achievement (net income share in the total amount of revenue raised to 16.61% in year 2 comparing to 11.52% in year 1.). However, this was followed by a slight decrease of this ratio during the year 3. Notable is also an increasing trend of gross profit margin (gross profit share in the total amount of revenue) over the period of three years. From this common-size statement of profit and loss we also can notice a big percent of research expenses, which means the company is trying to be innovative and invests resources in the development.

## Cash flow statement as an object of common-size analysis

Similarly to the common-size income statement, the cash flow statement can also be displayed in percentage of total sales. This would demonstrate different important cash flow items, such as capital expenditures and others, as a percentage of the revenue. One more important figure is debt issuance. Divided by the total sales it shows the percent of sales it generates. All the other items of the statement can also be reviewed in the context of their revenue generating ability.

See an example of the common-size cash flow statement below:

The average level of an operating cash flow was around 17-18% of sales over the reported period of three years, and the trend is declining. Share repurchased activity was also on a very good level of more than 13% of sales during three years. The first entry, which represents the net income divided by total sales, is exactly the same, as in the common-size income statement analysis, and profitability ratio analysis. It is the net profit margin.

## Role and benefits of common-size financial statement analysis

The main benefit of the common-size statement analysis is the ability to perform vertical analysis for a single period, and horizontal analysis over some periods, such as several quarters or years. Looking through the common-size financial statement of a company allows the investor or creditor to indicate some certain tendencies in company’s performance, that may have a big influence on the whole business in future. This analysis also gives us an insight into the company’s strategy, and the ability to define possible ways of its development.