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Common Size Financial Statement Definition
A common size financial statement is a financial statement or balance sheet that presents itself as a percentage of the base number of sales or assets. The financial statement reports owner equity, assets, and liabilities as percentages of the total assets. A financial statement like this gives the analysts an easier time when analyzing the profits of a company at different periods.
A Little More on What is Common Size Financial Statement
Note that most companies do not use the common size format to report their financial statements. Comparing two different companies in different economic sectors can be easier when using common size financial statements. Using percentages allows one to see changes in values over time.
Managers can also use the data to come up with new operations strategies. Balance sheets, income statements, and cash flow statements are examples of common size financial statements.
Types of common size financial statements
Common size financial statements are of various types, and each type makes use of different financial figures for standardization. The following are the types of common size statements:
- Common size balance sheet
A balance sheet gives a summary of the equity fund, liabilities, and assets of a company over time. The period can be quarterly or annually.
In a balance sheet; assets = liabilities + stockholders’ equity
In a common size balance sheet, the items present themselves as percentages of their base numbers. The assets are a percentage of the total assets. The same applies to liabilities and equity funds.
- Common size income statements
Most people refer to the income statement as a profit or loss statement. It provides an outline of expenses incurred, sales, and net income in a given financial reporting time. The income statement presents all items as a percentage of the total sales
In an income statement; net income = sales – expenses
- Common size cash flow statements
A cash flow statement shows the way cash is moving in and out of the firm. It also provides information about the sources and usage of money. Cash flows from the firm’s investments, cash flows from daily operations, and flows from financing are the subdivisions of the cash flow statement.
Limitations of common size financial statements
In general, financial statements present various limitations due to different interpretations when constructing the data. The limitations include:
- Companies using varying accounting policies when generating financial statements at different times. The same company could also be using different policies. The financial analysts need to adjust the data to ensure they are using the same policies to generate financial statements.
- Difficulty when comparing accounting periods as the companies may be using dissimilar accounting calendars.
- Inconsistencies in the preparation of financial statements make the common size aspect irrelevant when evaluating the performance of a firm.
- Common size financial statements do not provide concrete information to its users when there are fluctuations in the different financial components.
References for Common Size Statements
Academic Research for Common Size Statements
A content analysis of sell-side financial analyst company reports, Previts, G. J., Bricker, R. J., Robinson, T. R., & Young, S. J. (1994). Accounting Horizons, 8(2), 55. This research participates in the discussion of reporting practices of developing corporates. The authors analyze the content of basic analyst reports and make its comparison with annual reporting activities. With the help of content analysis methodology, the authors select a medium scale medico-tech firm globally recognized for its perfect business reporting. The findings are that the background data about the firm, including its products, industry and markets with the personal analysis of operating and financial data account for approximately fifty-five percent of the total disclosure in reports of basic analyst and the amount of supplied financial information does not correspond to other disclosures present in the report.
Company size, listed versus unlisted stocks, and the extent of financial disclosure, Buzby, S. L. (1975). Journal of accounting research, 16-37. This paper provides information about the financial disclosures extent, what should be company size and what is the difference between the listed and unlisted stocks. The author explains with the help of examples that the company size does not matter, but the disclosure extent is normally greater for listed firms as compared to unlisted ones. The difference applies to the data subset. An item may be subject to the company’s industry membership.
Voluntary financial disclosure by Mexican corporations, Chow, C. W., & Wong-Boren, A. (1987). Accounting review, 533-541. The latest financial corporate outrages show the accounting disclosure role in misleading the investors. This paper evaluates the determinants of voluntary disclosure strategy which a sample of a listed company in Tunisia adopts. The results show that the financial sector, firm leverage, profitability ratio and audio quality significantly determine the voluntary disclosure strategy in Tunisia. The banks play a vital role in financing the economy of Tunisia. Opposed to the predictions of the authors, the firm size and ownership structure have apparently no impact on disclosure strategy, as a concentrated ownership structure characterizes the companies in Tunisia with a homogeneous average size and a family character.
Company size and financial disclosure requirements with evidence from the segmental reporting issue, Salamon, G. L., & Dhaliwal, D. S. (1980). Journal of Business Finance & Accounting, 7(4), 555-568. This paper examines the effect of swap and index fund participation in future markets of energy and agricultural products. The findings are that the index funds do not lead to bubbling in the future prices of agricultural commodities. The authors use the Granger Causality Method and observe no significant empirical relation between positions of swap and index fund and enhanced market volatility. They present the strongest evidence for future markets of agricultural products. This is because they measure index trader position data with reasonable accuracy. There is no strong evidence in the 2 examined energy markets due to a great degree of uncertainty.
Financial reporting on the Internet by leading UK companies, Craven, B. M., & Marston, C. L. (1999). European Accounting Review, 8(2), 321-333. This paper aims to provide guidelines on how to use the internet for financial data between the listed firms of ASE (Amman Stock Exchange) for 2010. The authors investigate the degree of financial data dissemination on the internet by Jordanian firms in ASE stock exchange. The authors throw light on the factors affecting these firms in adopting the internet for providing financial disclosure. The findings are that 84 percent public listed firms of ASE have a web presence. The interim reports have the lowest internet reporting (only 73 percent). The authors also seek the impacts of 3 factors: profitability, leverage and firm size at the IFR (Internet Reporting).
Firm size, book‐to‐market ratio, and security returns: A holdout sample of financial firms, Barber, B. M., & Lyon, J. D. (1997). The Journal of Finance, 52(2), 875-883. This paper shows an important relationship between security returns, firm size and book-to-mark ratios for non-financial companies. Due to their interest in leverage being an explanatory variable, the authors exclude financial companies from their analysis, hence, generating a sample to check, to what extent, the results are robust. The findings are that the relationship between security returns, firm size and book-to-mark ratios is the same for financial as well as non-financial firms. They provide evidence that the survivorship bias has, in return, no significant influence on the book-to-mark premiums. These results show that selection bias and data snooping, in return, do not provide an explanation of the book-to-mark patterns and size.
New evidence on measuring financial constraints: Moving beyond the KZ index, Hadlock, C. J., & Pierce, J. R. (2010). The Review of Financial Studies, 23(5), 1909-1940. The authors collect a random sample of companies from 1995-2004 and obtain complete qualitative data from financial filings in order to classify financial constraints. With the help of this categorization, they assess ordered Logit approaches anticipating constraints as a function of various quantitative factors. The results are doubtful about the KZ index validity as a financial constraint measure when they present mixed evidence on other common constraint measures validity. The findings are that age and firm size are specifically useful predictors of levels of financial constraints. Finally, the authors present a financial constraints measure solely on the basis of these features of a firm.
Have financial statements lost their relevance?, Francis, J., & Schipper, K. (1999). Journal of accounting Research, 37(2), 319-352. This research investigates the Kuwait issue of a frontier market. The authors use the price regression model. They collect 2490 samples from all firms listed on the KSE (Kuwait Stock Exchange) for twenty-one years. The findings are that the decrease in the value relevance of earnings is more pronounced and deeper as compared to the book value. The findings are useful for the regulators since they provide an estimate of the effectiveness of the recent financial reporting environment. It focuses on the need for improvements as high-quality data assists equity holders to calculate value more precisely. This paper contributes to the research related to capital market changes in the value relevance of financial statement data by a statistical examination of a frontier capital market.
Effects of comprehensive-income characteristics on nonprofessional investors’ judgments: The role of financial–statement presentation format, Maines, L. A., & McDaniel, L. S. (2000). The accounting review, 75(2), 179-207. The SFAS (Statement of Financial Accounting Standards) number 130 requires firms to report whole income in a basic financial statement, but the presentation can be in the form of a comprehensive income statement or stockholders equity statement. The authors evaluate the effects of alternative formats of presentation on the processing of comprehensive income data of the nonprofessional investors, particularly, data disclosing the unrealized gains volatility on marketable securities available for sale. The findings are that the judgement of nonprofessional investors about the performance of management and corporate depict the comprehensive income volatility only when they present it in a comprehensive income statement. So, the formats affect the way, the nonprofessional investors weight their comprehensive income data.
Corporate governance and voluntary disclosure, Eng, L. L., & Mak, Y. T. (2003). Journal of accounting and public policy, 22(4), 325-345. This paper discusses the relationship between voluntary disclosure and corporate governance. Actually, understanding the corporate governance mechanism plays a vital role in determining the disclosure level and corporate governance. This paper aims to emphasize on understanding the impact of internal and external mechanisms of governance on data disclosed in yearly reports. The authors answer, the managers intend to disclose more or less. This study checks the degree of compliance with the requirements of governance regulation. It addresses the way, corporate governance affects data asymmetry between stakeholders and managers.
Audit‐firm tenure and the quality of financial reports, Johnson, V. E., Khurana, I. K., & Reynolds, J. K. (2002). Contemporary accounting research, 19(4), 637-660. This paper evaluates, for how long the relationship between an audit firm and a company exist with the quality of financial reporting. The authors use 2 proxies for quality of financial reporting and a Big six clients sample matched on size and industry. They find audit-firm tenures of 4 to 8 years as medium and 2 to 3 years as short tenures related to financial reports of low quality. They do not find any evidence of decreases quality of financial reporting for long-term audit firm tenures of 9 or more years. On the whole, the results show empirical evidence relevant to the recurring discussion which relies on isolated cases and anecdotal evidence.