Common-size Analysis – Introduction
Common-size analysis helps express a certain item as a ratio or percentage in relation to specific base item. For example in income statement usually the base item is total revenue and in balance sheet the common base item in reference to which others are expressed or evaluated are assets.
Common-size analysis helps understand the impact and influence of each item of financial statement and its contribution to the resultant. For example common-size analysis on income statement can help us understand that how significant are administrative costs in relation to sales and how much of the revenue is consumed by administrative expenses alone.
It won’t be wrong that common-size analysis is just another derivation of ratio analysis as we are identifying relationships between elements of financial statements and then basing our conclusions on resultants. Ratio analysis is no different than this. However, the result of common-size analysis is much more formal and renders like a report.
Types of Common-size Analysis There are mainly two ways in which common-size analysis can be conducted:
- Horizontal analysis
- Vertical analysis
Horizontal analysis helps analyse a line item by comparing it to similar line in either previous period or subsequent period. In simple words horizontal analysis helps compare two different time periods.
Vertical analysis analyse a specific line item of one financial statement in relation to base-item within same financial period. In simple words vertical analysis help express line items in relation to line item of our choice like total revenue.
These two techniques are applied majorly on three financial statements namely statement of financial position, income statement and statement of cash flows.