What is Common Size Analysis?

Common Size analysis is an accounting method used to measure each line item on the financial statements as a percentage of a base or common figure. For example, Revenue is often used as the base figure on the income statement. This means that all the line items such as cost of goods sold, gross profit, or net profit are displayed as a percentage of revenue. Common size analysis is an effective way to measure and compare specific line items within a business. It is easier to understand changes when comparing percentages rather than dollar amounts.

Common size statements are great tools for evaluating companies because they put every line item in context by looking at each of them as a percentage of sales.

Pat Dorsey

Common size analysis typically uses vertical analysis, which measures changes as they flow down the financial statements. Another method is horizontal analysis, which measures changes year-on-year for each line item against the same line item.

On the Income Statement, revenue is commonly used as the base figure. On the Balance Sheet, Total Assets are often use. Each line item is measured against the assets of a business. With the Cash Flow Statement, each line item (operating activity, investing activity, and financing activity) is displayed to represent how each activity contributes to the overall cash position.

I used common size analysis quite often. Usually on companies I am interested in that have already met certain criteria and warrant further investigation.

Why is Common Size Analysis helpful?

The most beneficial use of common size analysis is to speed up the initial analysis. By visibly displaying the line items as a percentage it allows us to observe changes more easily. It can help identify irregularities or line items that deviate from the average of the business, industry, or competitors.

For example, if a business reflects inventory against total assets of around 8%, and suddenly it is 19%, that immediately stands out. When we look at the value in dollars, we can see if it is high or low. The percentage puts that into context against the base figure. This is more helpful when understanding the impact of each line item on the business.

This form of analysis is much simpler and highlights certain percentages that warrant further research. Presenting each of the line items as a percentage provides a much more efficient look at the numbers, especially when comparing to other companies or how the company is improving every year.

Any significant movements in the financials across several years can help investors understand the trends in the business and whether it is moving in the right direction.

The formula to work out the percentages.

Line Item ÷ Base Figure x 100 = Common Size %

The Base or common figure is the line item you are going to use as the basis for the analysis. If we are using revenue as the base figure and wanted to get a common size analysis of net profit it would look like this.

Net Profit ÷ Revenue x 100

Assuming revenue is $100 and Net profit is $7.50, the percentage would be 7.5% ($7.50 ÷ $100 x 100). You can choose whatever base figure you want to use depending on the area you want to analyse.

How to use Common Size Analysis?

The way I use common size analysis is in the following four areas. This can provide valuable insights into the specific line items of the business.

Business Line-Item Analysis:

I use vertical common size analysis to compare the line items against the various base figures within a business. This helps me to see what is impacting areas such as revenue, total assets, and cash flows. I can immediately identify which line items are contributing to the overall business or perhaps areas that are lower than what I would like to see.

Business Performance Analysis:

This approach uses a horizontal common size analysis approach which compares the line items against each other on a year-to-year basis. This helps me to understand changes in the percentages and how the business is evolving over time. When represented as a percentage it’s easier to see what is rising or declining in comparison to past performance. When a percentage moves out of sync, it prompts us where to investigate and find what’s causing the dislocation.

Comparable Companies Analysis:

This measures the line items of the target company against its peers. When we see an opportunity, it can be hard to quantify why it is better or how the business model is more efficient. When comparing in percentages, it can shine a light on the areas within a business that are contributing to the performance. For example, our business spends 10% on R&D and competitors spend 5%.

Industry Comparison Analysis:

This can be helpful when comparing a potential investment to how it fits within an Industry. It can reveal why companies are performing better or highlight areas where a business is underspending. Investors want to understand if it is in line with, more, or less than the industry average. If so, what is causing the deviations?

An example using Common Size Analysis.

To illustrate how to use common size analysis let’s run a quick analysis of the small-cap company we’ve used throughout the financial statements section. We will lay the below income statement out in a table with the line items displayed as a percentage.

The base figure for this common size analysis is revenue. Revenue is $38.6 million. So we divide all of the line items by the revenue to get a percentage of each.

LINE ITEM:	AMOUNT:	%
Revenue	$38.6m	100%
Cost of Goods Sold	$18.1m	46.89%
Gross Profit	$20.4m	52.84%
Other Income	$0.5m	1.29%
Advertising	$0.22k	0.56%
D&A	$3.2m	8.29%
Employment Expenses	$5.4m	13.98%
Administration	$3.7m	9.58%
Repairs & Maintenance	$0.53k	1.37%
Finance Costs	$0.62k	1.60%
R&D	$0.44k	1.13
Other Expenses	$0.29k	0.75%
NOPAT Operating Profit	$6.3m	16.32%
Income Tax Expense	$1.6m	4.14%
NPAT (Net Profit)	$4.7m	12.17%

By using this method, we can effectively compare the sizes of different line items. In a single snapshot, investors can observe that Gross Profit looks good, Depreciation and Amortization make up a significant portion of the expenses, along with staffing and administration costs.

We can also see that the net profit is healthy, indicating that for every $100 of revenue, $12 is retained as pure profit. To analyze this further, we can assess how these line items have changed each year. Finally, we can use the line items to compare with other companies. This can reveal areas where our business is spending less or perhaps overspending. This is the usefulness of common size analysis.

In Summary…

I typically start my company research by analysing the last 5 years of financial statements, beginning with the income statement. It’s easy to carry out this exercise using Excel or Google Sheets. I use Tikr for all my research and analysis and can extract the data with just a click.

After reviewing the company’s financials, I then identify its closest competitor or peers and lay out their financials in a similar manner. Although this process doesn’t take long, the results are quite valuable. In one spreadsheet, I can gain insight into the operations of a business, the significance of certain line items, a comparison to competitors, and the company’s evolution over time.

I believe that using common size analysis is an efficient way to understand how a business operates and how it changes from year to year. This technique can reveal the strategies and insights a company employs. Comparing line items in percentages can provide clues about what is impacting significant changes in base figures, such as a growing asset base or rapidly increasing revenue.

Sometimes, a company’s competitive edge can be discovered through this analysis. It may also reveal the strengths and weaknesses of a business, such as the above graph reflecting where assets are spread around in comparison to other companies.

Looking at numbers from a monetary perspective alone may not provide the same insights as percentages, especially when comparing companies with different market caps. For example, one company spending $1m on depreciation and another spending $100m may seem like the latter has a far greater impact, but common size analysis may reveal that both have the same 10% expense against their revenue base. This approach allows for a like-for-like comparison that sometimes comparing in dollars can not provide.