Reading: Common-Size Financial Statements: Common-size financial statements

1. Common-size financial statements

Financial analysis typically starts with the so-called common-size financial statements. The idea is very simple: Because absolute values (in $, £, CHF, etc.) are difficult to interpret and compare, analysts choose a simple workaround and express all financial statements in percent of the statement's main item:

Common-size balance sheet: All balance sheet items are expressed in percent of total assets or in percent of total sales (revenues).
Common-size income statement: All income state items are expressed in percent of total sales (revenues).

This simple adjustment allows for a easy comparison across companies and over time. To illustrate, let's go back to Hershey's financial statements from the previous section. Remember that the actual balance sheets im thousands of USD were:

December 31,	2014	2015
ASSETS	(USD 1'000)	(USD 1'000)
Cash and cash equivalents	374'854	346'529
Short-term investments	97'131	0
Accounts receivable trade, net	596'940	599'073
Inventories	801'036	750'970
Deferred income taxes	100'515	0
Prepaid expenses and other	276'571	152'026
Total current assets	2'247'047	1'848'598
Property, plant and equipment, net	2'151'901	2'240'460
Goodwill	792'955	684'252
Other intangibles	294'841	379'305
Other assets	136'126	155'366
Deferred income taxes	0	36'390
Total assets	5'622'870	5'344'371

LIABILITIES AND STOCKHOLDERS EQUITY	(USD 1'000)	(USD 1'000)
Accounts payable	482'017	474'266
Accrued liabilities	813'513	856'967
Accrued income taxes	4'616	23'243
Short-term debt	384'696	363'513
Current portion of long-term debt	250'805	499'923
Total current liabilities	1'935'647	2'217'912
Long-term debt	1'542'317	1'557'091
Other long-term liabilities	526'003	468'718
Deferred income taxes	99'373	53'188
Total liabilities	4'103'340	4'296'909

Common stock	299'281	299'281
Class B common stock	60'620	60'620
Additional paid-in capital	754'186	783'877
Retained earnings	5'860'784	5'897'603
Treasury common stock shares, at cost	-5'161'236	-5'672'359
Accumulated other comprehensive loss	-358'573	-371'025
The Hershey Company stockholders equity	1'455'062	997'997
Noncontrolling interests in subsidiaries	64'468	49'465
Total stockholders equity	1'519'530	1'047'462
Total liabilities and stockholders equity	5'622'870	5'344'371

And the firm's income statements (also in thousands of USD) were:

For the years ended December 31,	2014	2015
Net sales	$7'421'768	$7'386'626
Costs and expenses:
Cost of sales	4'085'602	4'003'951
Selling, marketing and administrative	1'898'284	1'969'308
Impairment charges	15'900	280'802
Business realignment charges	29'721	94'806
Total costs and expenses	6'029'507	6'348'867
Operating profit	1'392'261	1'037'759
Interest expense, net	83'532	105'773
Other (income) expense, net	2'686	30'139
Income before income taxes	1'306'043	901'847
Provision for income taxes	459'131	388'896
Net income	$846'912	$512'951

Based on individual absolute numbers in these statements, it is fairly difficult to draw conclusions about the firm's financial performance. For example, it is difficult to judge whether a net income of 513 million in 2015 is a good result or not. The picture changes when we express the statements in common size, as shown below:

Common-size balance sheet

The first two columns of the following table express all balance sheet items in percent of total assets. For example, the cash and equivalents of 346.5 million in 2015 correspond to 6.5% of total assets of 5'344 million: $ \frac{346.5}{5'344} $ = 6.5%.

December 31,	2014	2015	2014	2015
ASSETS	(% Assets)	(% Assets)	(% Sales)	(% Sales)
Cash and cash equivalents	6.7%	6.5%	5.1%	4.7%
Short-term investments	1.7%	0.0%	1.3%	0.0%
Accounts receivable trade, net	10.6%	11.2%	8.0%	8.1%
Inventories	14.2%	14.1%	10.8%	10.1%
Deferred income taxes	1.8%	0.0%	1.4%	0.0%
Prepaid expenses and other	4.9%	2.8%	3.7%	2.0%
Total current assets	40.0%	34.6%	30.3%	24.9%
Property, plant and equipment, net	38.3%	41.9%	29.0%	30.2%
Goodwill	14.1%	12.8%	10.7%	9.2%
Other intangibles	5.2%	7.1%	4.0%	5.1%
Other assets	2.4%	2.9%	1.8%	2.1%
Deferred income taxes	0.0%	0.7%	0.0%	0.5%
Total assets	100.0%	100.0%	75.8%	72.0%

LIABILITIES AND STOCKHOLDERS EQUITY	(%)	(%)	(%)	(%)
Accounts payable	8.6%	8.9%	6.5%	6.4%
Accrued liabilities	14.5%	16.0%	11.0%	11.5%
Accrued income taxes	0.1%	0.4%	0.1%	0.3%
Short-term debt	6.8%	6.8%	5.2%	4.9%
Current portion of long-term debt	4.5%	9.4%	3.4%	6.7%
Total current liabilities	34.4%	41.5%	26.1%	29.9%
Long-term debt	27.4%	29.1%	20.8%	21.0%
Other long-term liabilities	9.4%	8.8%	7.1%	6.3%
Deferred income taxes	1.8%	1.0%	1.3%	0.7%
Total liabilities	73.0%	80.4%	55.3%	57.9%

Common stock	5.3%	5.6%	4.0%	4.0%
Class B common stock	1.1%	1.1%	0.8%	0.8%
Additional paid-in capital	13.4%	14.7%	10.2%	10.6%
Retained earnings	104.2%	110.4%	79.0%	79.5%
Treasury common stock shares, at cost	-91.8%	-106.1%	-69.5%	-76.4%
Accumulated other comprehensive loss	-6.4%	-6.9%	-4.8%	-5.0%
The Hershey Company stockholders equity	25.9%	18.7%	19.6%	13.4%
Noncontrolling interests in subsidiaries	1.1%	0.9%	0.9%	0.7%
Total stockholders equity	27.0%	19.6%	20.5%	14.1%
Total liabilities and stockholders equity	100.0%	100.0%	75.8%	72.0%

Common-size income statement:

Similarly, all income statement items are expressed in percent of net sales. For example, 2015's EBIT of 1'038 million corresponds to 14% of the firm's total sales of 7'387 million: $ \frac{1'038}{7'387} $ = 14%. This is the so-called EBIT margin.

For the years ended December 31,	2014	2015
	(% Sales)	(% Sales)
Net sales	100.0%	100.0%
Costs and expenses:
Cost of sales	55.0%	54.2%
Selling, marketing and administrative	25.6%	26.7%
Impairment charges	0.2%	3.8%
Business realignment charges	0.4%	1.3%
Total costs and expenses	81.2%	86.0%
Operating profit	18.8%	14.0%
Interest expense, net	1.1%	1.4%
Other (income) expense, net	0.0%	0.4%
Income before income taxes	17.6%	12.2%
Provision for income taxes	6.2%	5.3%
Net income	11.4%	6.9%

The common-size financial statements allow for much easier interpretation of the financial data. For example, we see that the 2015 business year was less successful than 2014 from a financial point of view. In particular, the EBIT margin dropped from 19% to 14% and the net income margin dropped from 11% to 7%. Moreover, the common-size numbers also allow us to make some first comparisons with other companies. For example, we can compare the EBIT margin of 14% in 2015 with that of other firms in the same industry, such as General Mills. It turns out that the EBIT margin of General Mills was very similar in 2015 --- 14.6%, according to Google Finance.