Statement analysis tools are essential in the field of accountancy for evaluating the financial health and performance of a business. Among these tools, Comparative Analysis and Common-Size Analysis are particularly significant. They help in comparing financial statements over different periods or against industry benchmarks. This study note will break down these tools into digestible sections, providing clear explanations, examples, and tips for better understanding.
Comparative Analysis involves comparing financial statements of different periods to identify trends and patterns. This method helps in understanding the growth, stability, and financial changes in a business over time.
The percentage change can be calculated using the formula: $$ \text{Percentage Change} = \left( \frac{\text{Current Period Amount} - \text{Previous Period Amount}}{\text{Previous Period Amount}} \right) \times 100 $$
Example
Example:
Consider the following data for a company's revenue:
Percentage Change: $$ \text{Percentage Change} = \left( \frac{600,000 - 500,000}{500,000} \right) \times 100 = 20% $$
This indicates a 20% increase in revenue from 2021 to 2022.
Tip
Always compare similar periods, such as fiscal years or quarters, to ensure consistency.
Common-Size Analysis involves expressing each item on the financial statements as a percentage of a base amount. This method standardizes financial statements, making it easier to compare different companies or periods.
For an Income Statement, the formula is: $$ \text{Common-Size Percentage} = \left( \frac{\text{Income Statement Item}}{\text{Total Revenue}} \right) \times 100 $$
Example
Example:
Consider the following data for a company's Income Statement:
Common-Size Percentage for COGS: $$ \text{Common-Size Percentage} = \left( \frac{400,000}{1,000,000} \right) \times 100 = 40% $$
This indicates that COGS is 40% of the total revenue.
For a Balance Sheet, the formula is: $$ \text{Common-Size Percentage} = \left( \frac{\text{Balance Sheet Item}}{\text{Total Assets}} \right) \times 100 $$
Example
Example:
Consider the following data for a company's Balance Sheet:
Common-Size Percentage for Inventory: $$ \text{Common-Size Percentage} = \left( \frac{300,000}{2,000,000} \right) \times 100 = 15% $$
This indicates that inventory constitutes 15% of the total assets.
Note
Common-Size Analysis is particularly useful when comparing companies in the same industry.
Common Mistake
A common mistake is to compare common-size percentages without considering the context, such as industry norms or economic conditions.
Comparative and Common-Size Analyses are powerful tools in financial statement analysis. They provide insights into a company's performance, trends, and structural changes, which are crucial for decision-making. By following the steps and understanding the formulas, you can effectively use these tools to analyze financial statements.
Tip
Regularly practice these analyses on different financial statements to build proficiency.