Analysis of Financial Statements: Comparative and Common-Size Statements
What the exam tests
Comparative and Common-Size Statements test horizontal and vertical analysis. Comparative statements show changes in absolute amounts and percentages from a base year. Percentage change = (current year amount - base year amount) / base year amount x 100. Common-size statements express each item as a percentage of a common base: revenue from operations is 100 in the income statement; total assets or total equity and liabilities is 100 in the balance sheet. Common-size analysis removes the effect of size and helps compare firms.
Worked example
Revenue rises from Rs. 5,00,000 to Rs. 6,00,000, a change of Rs. 1,00,000 or 20%. Cost of goods sold rises from Rs. 3,00,000 to Rs. 3,90,000, a change of Rs. 90,000 or 30%. Gross profit rises from Rs. 2,00,000 to Rs. 2,10,000, a change of Rs. 10,000 or 5%. In common-size terms, COGS was 60% and is now 65% of revenue; gross profit falls from 40% to 35%. The percentage analysis shows that costs grew faster than revenue, reducing margin.
Traps
Do not calculate percentage change with the current year as the denominator. A negative or zero base year makes percentage change misleading. Do not compare absolute rupee changes across firms of different sizes without common-size percentages. In common-size balance sheets, use total assets, not sales, as the base. Do not mix income statement and balance sheet bases.