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14. Financial Statement Analysis

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So let's discuss another tool of financial analysis. The use of common size statements. So what we're gonna see is that common size statements report only percentage amounts. Okay, they're not gonna show any dollar amounts were used to showing an income statement and balance sheet in the form of dollar amounts, right? But instead we're gonna show them as percentages. So this is exactly just the results of a vertical analysis. So if you want more practice with common size statements, just use vertical analysis, vertical analysis is the same exact thing. We're basically just showing the results of that vertical analysis. So like we learned with vertical analysis, the income statement base, we're gonna use a base for each of the statements when we do the income statement, the income statement base is going to be sales revenue. Okay, Our sales revenue. And on the balance sheet we'll use either the total assets or the total liabilities and equity. Remember these numbers are the same, right? Because assets, equal liabilities and equity. So it's gonna be the same number when we use the balance sheet. So what we're gonna do is we're gonna find a percentage of that base item and that's gonna be each line item. So you imagine we'll start with if it was an income statement, will show sales and show what percentage of Of our sales sales is and it's gonna be 100%. And then we'll show cost of goods sold what percentage of net sales is cost of goods sold and we'll keep going down and show each thing as a percentage of net sales on the balance sheet. It would be the same thing. We would have a certain amount of total assets and we would show how much of our total assets as cash as a percentage. And when we used Percentages, it makes it a lot easier to compare across companies because maybe companies are different sizes. So when we show cash in one business of $1 million, it might seem like a significant amount compared to a business that has cache of, say $50,000. But when we compare that as a percentage of our total assets, it's going to make a diff It's going to be able to be compared when it's percentages. Because if we have one million as our cash out of 10 million. Well, 10% of our balance is in cash. Whereas if we have 50,000 out of 500,000, well that's 10% of our balance in cash as well. Right? So as a percentage, we can compare different sized companies. That's the main benefit of common size statements. So just like with vertical analysis, we're going to use this formula percentage of the base the line item amount divided by the base amount and the base amount is going to be defined up here depending on which statement we're doing the income statement or the balance sheet. Okay, so let's go ahead and do an example, this is very similar to what we've already done with vertical analysis. So we're just gonna reiterate what we learned there. Okay, so let's calculate the common size percentages for each of for this income statement. So they gave us a pretty simple income statement here. Let's go ahead and do our common size statement. So remember our base is going to be net sales. So are the bottom part of our fraction will always be 150,000. So for this one it would be 100 and 50,000 divided by 100 and 50,000. And that gives us 100% right? It's gonna be 100%. And that's always gonna be like that for net sales because it's 100% of itself. Now, let's go on to cost of goods sold, cost of goods sold is 60,000 out of the 150,000. So what does that come out to 60,000, divided by 100 and 50,000? Well, that's 40%. So this tells us that 40% of our sales go to cost of goods sold, Right? And that obviously means that the rest is gonna be gross profit here. But let's calculate it 90,000, divided by 100 and 50,000, And that should equal .6, and it does right, 60%. And that should make sense, right? If 40% of it is cost of goods sold, well, the other 60% is our gross profit. So let's keep going here. Are operating expenses are 40,000 Out of the 150,000. So 40,000 divided by 150,000, it comes out to 26.6%, points all round it to 26.7%. So 26.7% is going to be um our operating expenses. And let's keep going 50,000 Out of the 150,000. Well that should be the subtraction there 60 minus the 26.7 will leave us with the 33.3% left for income of operations. Right? So one third of our net sales is income from operations. That's pretty good information right now, we know that one third of our net sales is income from operations for every dollar of sales. We have 33 cents is income from operations. Now our taxes 15,000 out of 150,000. Well that's 10% right there, 10% of our sales. And then finally 35,000 is left as net income out of 150,000. So 35 divided by 150, gives us 23.3%. So our net income is 23.3% of our net sales. That's good information. Now, this can help us compare amongst companies of different sizes when we just look at it from a percentage basis. Cool. So this isn't too complicated at all. You just have to remember what your base is gonna be on the income statement. You always use net sales on the balance sheet. You always use either total assets or total liabilities and equity. It's the same number. Cool. Alright, let's go ahead and move on to the next.

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