How To Make Common Size Balance Sheet

How to Make a Common-Size Balance Sheet: A Comprehensive Guide

Creating a common-size balance sheet is a crucial step in financial analysis. It allows for easy comparison of a company's financial health over time and against its competitors, regardless of the company's size. This comprehensive guide will walk you through the process step-by-step, explaining the underlying principles and showcasing practical examples.

Understanding the Common-Size Balance Sheet

A common-size balance sheet, also known as a vertical common-size balance sheet, expresses each line item as a percentage of a base figure. This base figure is typically total assets. By expressing each item as a percentage, you eliminate the impact of scale and focus on the relative proportions of assets, liabilities, and equity. This makes it much easier to identify trends and compare companies of different sizes.

For example, instead of seeing that a company has $1 million in cash, you'll see that cash represents, say, 5% of total assets. This percentage allows for more meaningful comparisons between the company's financial state this year and last year, or against a competitor with significantly different total assets.

Why Use a Common-Size Balance Sheet?

Common-size balance sheets offer several key advantages:

Improved Comparability: The most significant advantage is the ability to compare companies of different sizes. A small company with $100,000 in assets and a large company with $1 billion in assets can be directly compared based on the percentage of assets held in each category.
Trend Analysis: Tracking the percentage change in each line item over several periods provides insights into a company's financial strategy and operational efficiency. For instance, a consistently increasing percentage of accounts receivable could signal issues with collection efforts.
Benchmarking: Comparing a company's common-size balance sheet to industry averages or competitors' reveals its strengths and weaknesses relative to its peers. This can be invaluable for strategic decision-making.
Identifying Potential Problems: Significant deviations from industry norms or internal trends can alert analysts to potential problems requiring further investigation. For example, a rapidly increasing percentage of long-term debt could indicate excessive leverage.
Simplified Analysis: The common-size format simplifies the interpretation of complex financial data. It allows for a quick overview of the company's financial structure and its evolution over time.

How to Create a Common-Size Balance Sheet: A Step-by-Step Guide

Creating a common-size balance sheet involves several straightforward steps:

Step 1: Gather the Data

You will need the company's balance sheet data for the period you are analyzing. This typically includes:

Assets: Cash, accounts receivable, inventory, prepaid expenses, property, plant, and equipment (PP&E), investments, etc.
Liabilities: Accounts payable, salaries payable, short-term debt, long-term debt, etc.
Equity: Common stock, retained earnings, etc.

Step 2: Calculate Total Assets

Sum all the assets listed on the balance sheet to arrive at the total assets figure. This will be your base figure for calculating percentages.

Step 3: Calculate Percentages for Each Asset Item

For each asset, divide its value by the total assets and multiply by 100%.

Formula: (Individual Asset / Total Assets) * 100%

Step 4: Calculate Percentages for Each Liability Item

Repeat step 3 for each liability item, using the same formula but dividing the individual liability value by total assets.

Step 5: Calculate Percentages for Each Equity Item

Repeat step 3 for each equity item, again dividing the individual equity value by total assets.

Step 6: Create the Common-Size Balance Sheet

Organize the data in a table format, listing each item (assets, liabilities, and equity) and its corresponding percentage of total assets. The sum of the percentages for assets should equal 100%, while the sum of the percentages for liabilities and equity should also equal 100%.

Example: Creating a Common-Size Balance Sheet

Let's illustrate the process with a hypothetical example. Consider the following balance sheet data for Company X:

Company X Balance Sheet (in $000s)

Asset	Amount
Cash	10
Accounts Receivable	20
Inventory	30
Property, Plant & Equipment	100
Total Assets	160

Liability/Equity	Amount
Accounts Payable	15
Short-term Debt	25
Long-term Debt	50
Common Stock	50
Retained Earnings	20
Total Liabilities & Equity	160

Calculating Percentages:

Cash: (10 / 160) * 100% = 6.25%
Accounts Receivable: (20 / 160) * 100% = 12.5%
Inventory: (30 / 160) * 100% = 18.75%
Property, Plant & Equipment: (100 / 160) * 100% = 62.5%
Accounts Payable: (15 / 160) * 100% = 9.38%
Short-term Debt: (25 / 160) * 100% = 15.63%
Long-term Debt: (50 / 160) * 100% = 31.25%
Common Stock: (50 / 160) * 100% = 31.25%
Retained Earnings: (20 / 160) * 100% = 12.5%

Company X Common-Size Balance Sheet

Item	Percentage of Total Assets
Assets:
Cash	6.25%
Accounts Receivable	12.5%
Inventory	18.75%
Property, Plant & Equipment	62.5%
Total Assets	100.00%
Liabilities & Equity:
Accounts Payable	9.38%
Short-term Debt	15.63%
Long-term Debt	31.25%
Common Stock	31.25%
Retained Earnings	12.5%
Total Liabilities & Equity	100.00%

Analyzing the Common-Size Balance Sheet

Once you have created the common-size balance sheet, you can start analyzing the data. Look for:

Significant changes in percentages over time: This indicates shifts in the company's financial structure and operations.
Deviations from industry averages or competitor benchmarks: This helps to assess the company's competitive position and identify areas for improvement.
Unusual patterns or inconsistencies: These may warrant further investigation.

Common-Size Balance Sheet vs. Common-Size Income Statement

While similar in principle, the common-size balance sheet and common-size income statement have different base figures. The common-size balance sheet uses total assets as the base, while the common-size income statement uses total revenue. Analyzing both statements together provides a more holistic view of a company's financial performance and position.

Advanced Applications and Considerations

Trend Analysis: Prepare common-size balance sheets for multiple periods to track changes in the proportion of assets, liabilities, and equity over time.
Cross-Sectional Analysis: Compare the common-size balance sheet of a company to its competitors or industry averages to identify strengths and weaknesses.
Using Different Base Figures: While total assets are the most common base, other figures like total equity or total liabilities might be relevant in certain contexts. Choose the base figure most appropriate for your analysis.

Conclusion

Creating a common-size balance sheet is a powerful technique for financial analysis. By expressing balance sheet items as percentages of total assets, you can easily compare companies of different sizes, track trends over time, and benchmark performance against industry peers. This process, while seemingly simple, offers invaluable insights into a company's financial health and strategic direction. Mastering this technique is essential for anyone involved in financial analysis, investment decision-making, or business management. Remember to always consider the context of the data and use your analysis to inform, not dictate, your decisions.