Question

short essay: why common- size analysis?

Answer 1

A common size financial statement is one in which all the line items are expressed as a proportion of one base item which is usually the revenue. Thus the cost of goods sold, interest expense and net profits are all expressed as percentages of the base figure which is the revenue. Thus using a common size financial statement, it becomes easier to compare the performance of the company over time or even to compare its performance with its industry peers.

Such an analysis good provide insights into the operating efficiency, margins available for the business and how it has evolved over time. This helps in understanding trends in the business such as increasing wages, finance costs or increase or decrease in raw material costs over time. All this provide a way to understand the competitive position of the company with regards to other competitors in terms of each other's conversion costs and profit margins.