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Common Size Analysis: Comparing Intra-Firm and Inter-Firm Ratios for Financial Statements, Schemes and Mind Maps of History

Isabela State University (ISU)History

A solution to a financial analysis problem that involves preparing both vertical and horizontal common size analyses of an income statement and cash flow statement. Common size analysis is a financial ratio analysis technique used to compare financial statements of different companies or the same company over time, by expressing each line item as a percentage of net sales or total assets. The analysis helps in understanding the relative size and composition of various components of the financial statements and identifying trends and anomalies.

Typology: Schemes and Mind Maps

2021/2022

Uploaded on 08/01/2022

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7. Common-Size Analysis
7.1 Financial ratios
Financial ratios can be calculated as a percent or as times per period.
Two types of analyses can be done:
an intra-firm (trend) analysis
an inter-firm (industry) analysis
In an intra-firm financial ratios are compared to prior ratios. Trend analysis studies the
financial history of a company. Usually rising ratios prove the good quality of management.
In an inter-firm analysis financial ratios are compared to ratios of competitors. These
ratios can be also compared to industry ratios or determined standard ratios. The analysis of a
company’s financial statements is more meaningful if the ratios are compared with results of
competitors or with industry averages. Sometimes it is difficult to find a peer company, because
companies do not fit into any one industry.
Financial ratios vary by type of industry. Many of ratios calculated for a company can be
compared only with ratios with companies in the same industry.
A manufacturing firm will usually have large inventories of raw materials, work in
progress and finished goods.
A retail or wholesale companies sell products purchased from other companies.
Inventories are usually huge and consist mostly of finished products.
A service company usually has very low inventories which mostly consist of finished
goods.
It is necessary to understand that all income statement and cash flow statement items are
flow variables and cover the reporting period. All balance sheet items are stock variables and
apply to a single date, the end of the reporting period. Sometimes, average of the beginig and
the ending balance item is calculated. Sometimes this approach may be misleading.
7.2 Common-Size Analysis
Common-size analysis shows ratios in percentages (for example current assets / total
assets, long-term assets / total assets).
Vertical analysis compares each item with a base item. In an income statement analysis
net operating income is the base item. In a common-size balance sheet analysis total assets is
the base item. In a statement of cash flow analysis net cash flows from investing activities
should be a base item as usually net cash outflows from investing activities are financed with
wit positive net cash flows from operating activities and positive net cash flows from financing
activities.2
Horizontal analysis compares each item with an item for a selected base year.
2 This is my proposal. I’m not sure whether companies use such an approach.
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7. Common-Size Analysis

7.1 Financial ratios

Financial ratios can be calculated as a percent or as times per period.

Two types of analyses can be done:

 an intra-firm (trend) analysis

 an inter-firm (industry) analysis

In an intra-firm financial ratios are compared to prior ratios. Trend analysis studies the

financial history of a company. Usually rising ratios prove the good quality of management.

In an inter-firm analysis financial ratios are compared to ratios of competitors. These

ratios can be also compared to industry ratios or determined standard ratios. The analysis of a

company’s financial statements is more meaningful if the ratios are compared with results of

competitors or with industry averages. Sometimes it is difficult to find a peer company, because

companies do not fit into any one industry.

Financial ratios vary by type of industry. Many of ratios calculated for a company can be

compared only with ratios with companies in the same industry.

A manufacturing firm will usually have large inventories of raw materials, work in

progress and finished goods.

A retail or wholesale companies sell products purchased from other companies.

Inventories are usually huge and consist mostly of finished products.

A service company usually has very low inventories which mostly consist of finished

goods.

It is necessary to understand that all income statement and cash flow statement items are

flow variables and cover the reporting period. All balance sheet items are stock variables and

apply to a single date, the end of the reporting period. Sometimes, average of the beginig and

the ending balance item is calculated. Sometimes this approach may be misleading.

7.2 Common-Size Analysis

Common-size analysis shows ratios in percentages (for example current assets / total

assets, long-term assets / total assets).

Vertical analysis compares each item with a base item. In an income statement analysis

net operating income is the base item. In a common-size balance sheet analysis total assets is

the base item. In a statement of cash flow analysis net cash flows from investing activities

should be a base item as usually net cash outflows from investing activities are financed with

wit positive net cash flows from operating activities and positive net cash flows from financing

activities.^2

Horizontal analysis compares each item with an item for a selected base year.

2 This is my proposal. I’m not sure whether companies use such an approach.

Task 7

  1. Prepare a vertical and common size analysis of Income Statement
  2. Prepare a vertical and common size analysis of Balance Sheet
  3. Prepare a vertical and common size analysis of Cash Flow Statement Problem 15. Common Size Analysis of Income Statement Required: (a) Prepare a vertical Common Size of Income Statement (b) Prepare a horizontal Common Size of Income Statement Solution (a) Vertical Common Size of Income Statement Dec. 31, 2014 Dec. 31, 2013 Dec. 31, 2012 NET OPERATING REVENUES 100,0% 100,0% 100,0% Cost of goods sold 38,9% 39,3% 39,7% GROSS PROFIT 61,1% 60,7% 60,3% Selling, general and administrative expenses 37,4% 36,9% 36,9% Other operating charges 2,6% 1,9% 0,9% OPERATING INCOME 21,1% 21,8% 22,4% Interest income 1,3% 1,1% 1,0% Interest expense 1,1% 1,0% 0,8% Equity income (loss) - net 1,7% 1,3% 1,7% Other income (loss) - net -2,7% 1,2% 0,3% INCOME BEFORE INCOME TAXES 20,3% 24,5% 24,6% Income taxes 4,8% 6,1% 5,7% CONSOLIDATED NET INCOME 15,5% 18,4% 18,9% (b) Horizontal Common Size of Income Statement Dec. 31, 2014 Dec. 31, 2013 Dec. 31, 2012 NET OPERATING REVENUES 98,8% 100,7% 103,2% Cost of goods sold 98,2% 101,1% 104,6% GROSS PROFIT 99,2% 100,4% 102,2% Selling, general and administrative expenses 98,8% 99,4% 101,8% Other operating charges 161,6% 122,3% 61,1% OPERATING INCOME 95,4% 100,5% 106,0% Interest income 123,0% 110,6% 97,5% Interest expense 115,8% 111,0% 95,2% Equity income (loss) - net 111,4% 87,2% 118,7% Other income (loss) - net -238,8% 108,9% 25,9% INCOME BEFORE INCOME TAXES 81,4% 100,2% 103,1% Income taxes 78,3% 101,4% 96,8% CONSOLIDATED NET INCOME 82,4% 99,8% 105,1%

Horizontal Common Size of Balance Sheet CURRENT ASSETS Dec. 31, 2014 Dec. 31, 2013 Dec. 31, 2012 Cash and cash equivalents 70% 81% 66% Short-term investments 832% 616% 461% TOTAL CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS 130% 123% 97% Marketable securities 2545% 2185% 2147% Trade accounts receivable, less allowances of $61 and $53, respectively 91% 99% 97% Inventories 100% 106% 106% Prepaid expenses and other assets 89% 84% 81% Assets held for sale TOTAL CURRENT ASSETS 129% 123% 119% EQUITY METHOD INVESTMENTS 138% 144% 127% OTHER INVESTMENTS, PRINCIPALLY BOTTLING COMPANIES 322% 98% 108% OTHER ASSETS 126% 133% 103% PROPERTY, PLANT AND EQUIPMENT - net 98% 100% 97% TRADEMARKS WITH INDEFINITE LIVES 102% 105% 102% BOTTLERS' FRANCHISE RIGHTS WITH INDEFINITE LIVES 86% 95% 95% GOODWILL 99% 101% 100% OTHER INTANGIBLE ASSETS 84% 91% 92% TOTAL ASSETS 115% 113% 108% Dec. 31, 2014 Dec. 31, 2013 Dec. 31, 2012 CURRENT LIABILITIES 102% 106% 96% Accounts payable and accrued expenses 149% 131% 127% Loans and notes payable 174% 50% 77% Current maturities of long-term debt 110% 85% 130% Accrued income taxes Liabilities held for sale 133% 115% 115% TOTAL CURRENT LIABILITIES 140% 140% 108% LONG-TERM DEBT 81% 65% 101% OTHER LIABILITIES 120% 131% 106% DEFERRED INCOME TAXES THE COCA-COLA COMPANY SHAREOWNERS' EQUITY 100% 100% 100% Common stock, $0.25 par value; Authorized - 11,200 shares; Issued - 7,040 and 7,040 shares, respectively 127% 119% 110% Capital surplus 118% 115% 108% Reinvested earnings 208% 124% 122% Accumulated other comprehensive income (loss) 135% 125% 112% Treasury stock, at cost - 2,638 and 2,571 shares, respectively 96% 105% 104% EQUITY ATTRIBUTABLE TO SHAREOWNERS OF THE COCA-COLA COMPANY 84% 93% 132% EQUITY ATTRIBUTABLE TO NONCONTROLLING INTERESTS 96% 105% 104% TOTAL EQUITY 115% 113% 108%

Problem 17. Common Size Analysis of Cash Flow Statement Required: (a) Prepare a vertical Common Size of Cash Flow Statent (b) Prepare a horizontal Common Size of Cash Flow Statent Solution (a) Vertical Common Size of Cash Flow Statement Dec. 31, 2014 Dec. 31, 2013 Dec. 31, 2012 CONSOLIDATED NET INCOME 95% 205% 80% Depreciation and amortization 26% 47% 17% Stock-based compensation expense 3% 5% 2% Deferred income taxes -1% 15% 6% Equity (income) loss - net of dividends -5% -5% -4% Foreign currency adjustments 6% 4% -1% Significant (gains) losses on sales of assets - net 11% -16% -1% Other operating charges 10% 11% 1% Other items 2% 6% 2% Net change in operating assets and liabilities -6% -22% -9% Net cash provided by operating activities 141% 250% 93% INVESTING ACTIVITIES Purchases of investments -237% -351% -130% Proceeds from disposals of investments 173% 304% 68% Acquisitions of businesses, equity method investments and nonmarketable securities -5% -8% -13% Proceeds from disposals of businesses, equity method investments and nonmarkatable securities 2% 21% 0% Purchases of property, plant and equipment -32% -61% -24% Proceeds from disposals of property, plant and equipment 3% 3% 1% Other investing activities -4% -7% -2% Net cash provided by (used in) investing activities -100% -100% -100% FINANCING ACTIVITIES Issuances of debt 555% 1030% 375% Payments of debt -492% -919% -338% Issuances of stock 20% 32% 13% Purchases of stock for treasury -55% -115% -40% Dividends -71% -118% -40% Other financing activities -5% 0% 1% Net cash provided by (used in) financing activities -48% -89% -29% EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS -12% -14% -2% CASH AND CASH EQUIVALENTS Net increase (decrease) during the year -19% 47% -38% Balance at beginning of year 139% 200% 112% Balance at end of year 119% 247% 74% Net increase (decrease) during the year -19% 47% -38%