How to Perform Common-Size Analysis: A Six-Step Order

Common-size analysis restates every line of a statement as a percentage of one base: income statement lines against revenue, balance sheet lines against total assets. Six steps, in order: fix the basis, choose the base and state it, restate every line, compare the years, separate what moved in the mix from what moved in the money, and write down what would settle the rest. The restatement makes shape visible and hides size entirely.

The technique rests on nothing new. All three statements for both years are already in hand, along with the margin ladder and the composition of the assets. A margin ladder is a common-size income statement whether anyone called it that or not. Order is what the six steps add, not arithmetic, along with one analytical step that a table alone will never perform.

What is common-size analysis, and what is it for?

Consider how somebody else's household budget reads. Their earnings are unknown, so a friend who says they spent Rs 18,000 on rent last month conveys almost nothing. A friend who says rent took 45 per cent of what came in conveys a great deal, and that number can be held against their own figure from two years ago without either salary being known. Dividing everything by one common figure, so the numbers can be compared without knowing the size, is the whole of the technique.

Applied to a set of accounts it has an older name. Reading one statement downwards, every line as a share of one base, is vertical analysisReading a single statement down its own column, with every line expressed as a share of one chosen base figure.. Reading the same line sideways across two or more dates to see how it moved is horizontal analysisReading one line across two or more dates to see the change in it. A different reading direction from going down a single column.. Common-size analysis is the first of those two, and the six steps below run it on both statements of the same invented business, Anjani Stationers, a printer and supplier of school exercise books.

The purpose is comparability without size. A restated column can be laid beside the same business a year earlier and read directly. Both columns end at 100, and neither carries any information about how big the business was. Comparability without size is the trade, and the second half of that trade is the part most readers forget by the time they write their note.

In what order is it performed?

Six steps, and the order is not decorative. Steps one and two decide what the percentages will mean before a single division happens; getting them wrong produces a table of confident numbers that answer a question nobody asked. Step five is the one that turns a table into an analysis. Step six is the one that says when to stop.

Step one, fix the basisThe set of choices that fixes what a set of figures covers: which reporting entity, which dates, and which accounting policies. Two statements on different bases are not comparable however carefully they are divided.. Decide whether the standalone accounts or the consolidated ones are being read, decide which two dates, and check whether any change of policy or any prior period correction sits between them. The 70 per cent holding in Chitra Binding Works was bought at the start of year two, so Anjani Stationers is read standalone throughout. A group column on one side against a single company column on the other would produce a change of shape that has nothing to do with trading.

Step two, choose the base and print it. Step three, restate every line. Step four, lay the two years side by side. Step five, split each material move into its two parts. Step six, write down what remains unknown and what would settle it. Every step produces an artefact that can be handed to somebody else, and a step that produces nothing to hand over was skipped.

What serves as the base, and why does the choice matter?

The baseThe single figure that every other line is divided by. Revenue for the income statement and total assets for the balance sheet are the usual choices, and they are choices rather than rules. is revenue for the income statement and total assets for the balance sheet. Revenue and total assets are the conventional choices and the ones used here, and they are not the only defensible ones. Plenty of readers divide the balance sheet by capital employed, Rs 1,52,00,000 for Anjani Stationers in year two, or by equity, Rs 1,42,00,000. Both give a coherent picture. Neither gives the same percentages.

The matching figures are worth pausing on. Employee cost of Rs 42,00,000 against revenue of Rs 2,70,00,000 gives 15.6 per cent. Inventory of Rs 28,00,000 against total assets of Rs 1,80,00,000 gives 15.6 per cent. Written on a slide without their bases, those two figures are indistinguishable, and a reader who sees them side by side has no way to tell that one describes a year of trading and the other describes a moment in time. A percentage without its base is not a fact, it is a fragment.

What does the restated income statement look like?

Here is the restatementRewriting each line as a share of the chosen base so the column reads in percentages. Not to be confused with the accounting sense of restating a prior period to correct an error. of both years, every line, divided by that year's own revenue. Year two revenue is Rs 2,70,00,000 and year one is Rs 2,40,00,000, and both ladders were published earlier in these notes.

Two decisions inside that table are worth naming. Both are step one and step two decisions rather than arithmetic. Year two splits into Rs 3,50,000 of finance cost and Rs 8,00,000 of tax, and year one's split is not on record here, so finance cost and tax are carried as a single line on both sides. Carrying them separately on one side and together on the other would have produced two columns that are not comparable at the bottom. The six expense shares in each column add to exactly 100.0 with profit after tax included, and that total is the arithmetic check that step three was actually completed.

What does the restated balance sheet look like?

The restatement earns its keep on the asset side. The margin ladder was already a restated income statement. The asset side was not. Year two total assets are Rs 1,80,00,000. Year one total assets are Rs 1,33,00,000, and the year one shares below are computed from that published total. The line by line split of year one is an assumption applied consistently across these notes rather than a separately published breakdown, and it is labelled as such wherever it appears.

Each share above is rounded to one decimal place, so the printed lines in a column can add to 100.1 while the column itself is exactly 100. A reader who adds the printed figures and gets 100.1 will wonder which line is wrong, and none of them is. Say the rounding out loud on any table handed over.

How is the mix separated from the level?

Step five is the only one that cannot be done by a spreadsheet formula. Every line now has two independent stories. The mixThe share a line takes of the base. A mix change means the shape of the statement moved, whatever happened to the money. is what share it takes of the base. The levelThe money itself, in rupees, before any division. Also called the absolute figure. is the money itself, before any division. Mix and level can move in the same direction, in opposite directions, or one can move while the other stands completely still.

Take trade receivables at Anjani Stationers. Net receivables took 56.4 per cent of total assets at the first date and 47.8 per cent at the second, a fall of 8.6 percentage points. Over the same twelve months net receivables rose from Rs 75,00,000 to Rs 86,00,000, or Rs 11,00,000 more money owed by schools than the year before. A falling percentage and a rising amount are not in conflict, and an analyst who reports either one alone has reported half the story.

The reconciliation is simple once the base is brought into view. Total assets rose from Rs 1,33,00,000 to Rs 1,80,00,000, up Rs 47,00,000 or 35.3 per cent. Net receivables rose 14.7 per cent. A line that grows more slowly than its base loses share by definition, however much money it added. Rs 21,00,000 of that Rs 47,00,000 of asset growth is the new holding in Chitra Binding. The holding did not exist on the earlier date at all, and it alone accounts for a large part of the dilution of every other share on that column.

A second reading of the same line is equally correct and gives different numbers, and that is why step one insists on fixing the basis first. Gross receivablesThe full amount customers owe before the provision for doubtful debts is subtracted. Net receivables are what is left after it., before the provision for doubtful debts, went from Rs 78,00,000 to Rs 95,00,000, a rise of Rs 17,00,000, and on that basis the share fell from 58.6 per cent to 52.8 per cent. Same business, same dates, same direction on both scales, and not one of the four numbers is interchangeable with the net figures above. Mixing a gross figure on one date with a net figure on the other is the most common way a restated table quietly stops meaning anything.

The three shapes a move can take

The software row is the one to keep. Software did not move by a single rupee across the two dates, and its share fell by 0.8 points anyway. Restating only the interesting lines, with this one among them, would have produced a sentence about a line where nothing whatsoever happened. Every percentage on a restated statement is a fraction with two moving parts, and which part moved cannot be told without looking at the money.

What does restating everything as a percentage hide?

Size. Completely. A restated column has had the one number that carries scale divided out of every line, and no operation performed on the percentages will get it back. Two businesses with identical restated statements, one of them ten times the other, are indistinguishable on those columns, and the method has nothing to say about the difference between them.

Losing size is not a defect but the trade made in step two, in order to compare a business with itself across two years of very different size. But it means the restated column can never travel alone. The money column goes with it, on the same sheet of paper, every time.

What happens when a share is read without its money?

How does a lender or an analyst actually use this?

A working capital lender looking at Anjani Stationers is not primarily interested in whether receivables are large. The lender is interested in what happens to the loan if the schools pay late. The restated column tells them that at the second date, 47.8 per cent of everything the business has is money it has billed and not collected, and a further 15.6 per cent is paper and board sitting in a store room. Roughly 63 per cent of the asset side has to convert through somebody else's payment behaviour before it becomes cash. The 63 per cent is a statement about shape, and it holds whether the business is this size or ten times it.

The lender then reaches for the money column for the second half. Rs 86,00,000 net is what would actually be at stake, against cash of Rs 5,00,000 on hand. The share told them where the risk lives; the money told them how much of it there is. Neither column is the analysis, and a credit note built on either one alone would be rejected by any competent reviewer.

An equity analyst uses the income statement side the same way. The restated ladder shows materials holding exactly 55.0 per cent of revenue across both years. The entire fall in profit after tax, from 15.8 to 11.1 per cent of revenue, therefore happened below the gross profit line, in employee cost, other operating expenses and depreciation. One observation identifies which four lines to open the notes for and which one to leave alone, before anything at all has been computed. The technique locates the question. Answering it is somebody else's step.

When does it stop?

The work stops when four things are true, and not before. Both statements are restated, every line. Both years sit side by side. Every material move has been split into its mix part and its money part, and no share is reported without the rupees behind it. The questions that could not be settled are written down with the specific evidence that would settle each one. The next person then does not repeat the work.

Step six is worth writing down because it prevents step seven, and the method has no step seven. A restated table invites the reader to keep going, to declare that a 47.8 per cent receivables share is too high, or that materials at 55 per cent should be lower. Neither claim can be settled from one business at two dates, with no peer group and no outside figure to hold the shares against. The restatement leaves behind a map of where the shape moved and a list of what to open next, a great deal more than most notes contain.

Anjani Stationers Private Limited, Chitra Binding Works and Vaidehi Rao are invented.
Educational material. Not advice on any investment, tax, budget or market position.