Why is it so important to create common-size statements when comparing different companies' financial statements?


Quick Answer

Common-size financial statements allow analysts to compare different companies with different levels of business against a common standard. The purpose of common-size financial statements is to remove those financial differences between companies that have nothing to do with their primary operations. They are often used to compare different sized companies in the same industry but can also be used to compare companies in similar but different industries.

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Full Answer

Common-size financial statements are created by converting each item on a company's financial statement into a percent. This is done by dividing each item by a common standard. For example, the inventory can be converted into a percent by dividing it by the total amount of assets the business has. This way the inventories of two businesses can be directly compared. Typically, income statement items are converted to a percent of total revenue, and balance sheet items are converted to a percentage of total assets.

Another purpose for common-size financial statements is to compare different periods of business for the same company. Placing common-size financial statements for different years side-by-side gives a good picture of business trends over time. In most businesses, the percentages on the common-size financial statement stay more similar than the dollar amounts on the actual income statements and balance sheets.

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