What is a Common Size Balance Sheet?
A common size balance sheet is one that has an additional column showing each monetary amount as a percentage of the total assets of the business. The common size balance sheet is not required by Accounting Standards, and is used more as a management tool rather than a formal reporting document.
There is no set format to the common size balance sheet, but it is best to keep the same balance sheet format required by accounting standards, and then add an additional column to the right representing the percentage of total assets.
Example of Common Size Balance Sheet
A typical layout is shown in the example below. This example shows a vertical common size balance sheet with the right hand column showing each line item as a percentage of total assets.
|Long term assets||133,714||64.6%|
|Total liabilities and equity||207,000||100.0%|
In a common size balance sheet the right hand column shows each line item as a percentage of total assets. For example, current assets are shown in the balance sheet at a value of 73,286, and the total assets are shown as 207,000. As a percentage, current assets represents 73,286/207,000 = 35.4% of total assets.
From the accounting equation, we know that the total assets of the business are the same as the total liabilities and equity, and so the right hand column also shows each line as a percentage of total liabilities and equity.
Common Size Balance Sheet Analysis
Common size balance sheet analysis allows a business to perform a number of tasks as follows:
To show what proportion each item represents of the total assets of the business.
In the above example, accounts receivable is shown as being 27.7% of the total assets, compared to inventory at 0.9%. Clearly, the common size balance sheet identifies accounts receivable as the more important item to consider when the business monitors its working capital requirements.
To analyze changes in the balance sheet of the business over time.
By producing a common size balance sheet at the end of each accounting period, it is possible to monitor changes in each line item over time. For example, the following shows the vertical common size analysis for two accounting periods.
Clearly, the business has expanded between the two accounting periods and the absolute values of each line item are significantly higher. However, a quick glance at the common size balance sheet in the right hand percentage columns, shows that for most items the percentages are similar.
For example, the accounts receivables has increased from 57,263 to 112,637 over the two periods. The common size balance sheets, however, shows that as a proportion of total assets accounts receivable has remained fairly constant at 27.7% and 27.2% of total assets. The conclusion is that, providing this level of accounts receivable is standard for the industry, the increase is as a result of the growth in the business and not due increased credit terms or to poor collection procedures.
By monitoring the trend of the common size balance sheet percentage for each line item, it is easy to spot changes which may need correcting.
To make comparisons of the business with other businesses irrespective of their relative size.
A similar process to that used above can be applied to compare two different businesses. In the example below. the common size balance sheets are for two different businesses of differing sizes.
While it is difficult to compare the absolute values of these two businesses, the common size balance sheet shows that relative to total assets, the first business has a much larger investment in long term assets (64.6% compared to 30.8%) and a much smaller investment in inventory (0.9% to 19.7%). On the liabilities and equity side, the first business is relying on retained profits (50.1% to 7.7%) to fund the business rather than additional liabilities (40.3% compared to 69.3%), and capital (9.5% compared to 23.0%) used by the second business.
This example is of two business in two very different industries and the common size balance sheet clearly highlights the differences irrespective of their relevant size.
The comparison could equally be done between the business and a competitor in the same industry or with industry averages, thereby highlighting any differences in operation which may need correcting. For example if the common size balance sheet shows that your accounts receivable is 27.7% of total assets and a competitors was say only 15% of total assets, it could indicate problems with your credit terms or your collection procedures.
Our common size balance sheet calculator is available and can be used to make the calculations and comparisons referred to above.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.