A common size balance sheet is an alternative form of the traditional balance sheet financial statement. Where a normal balance sheet expresses information as total financial figures for a specific period in time, a common size one displays each figure as a percentage of the total value for a class of financial information. For example, if a company lists $1,000 US Dollars (USD) in accounts receivable and total balance sheet current assets of $8,000 USD, the common size statement would report accounts receivable as 12.5 percent (1,000 / 8,000). Each section of the balance sheet — assets, liabilities, and owner’s equity or retained earnings — is presented this way.
Balance sheets are typically broken out into the aforementioned sections. Each section will include a total figure so managers can determine the amount of assets, liabilities, and equity in their respective companies. Using the figures above, assume the following appears on a regular balance sheet: $1,200 USD cash, $1,000 USD accounts receivable, $5,000 USD inventory, and $800 USD marketable securities. The common size balance sheet would show this information as 15 percent cash, 12.5 percent accounts receivable, 62.5 percent inventory and 10 percent in marketable securities, for a total of 100 percent.
Creating a common size balance sheet can help business owners and managers spend less time reviewing their companies' financial information. While it is important to know the total dollar value of items, representing them as a percentage allows owners and managers to discover where the company has the most cash wrapped up. For example, copious amounts of inventory can indicate lower cash balances. High accounts receivable can represent lower cash and inventory balances since companies are selling more goods on account rather than cash sales. Liabilities can also tell similar stories. Significant increases in accounts payable, credit lines, or other short-term notes payable can indicate that a company needs external financing for its operations. This situation can create difficult future cash flows and other business situations in coming years.
The common size balance sheet also allows business owners and managers to review their long-term assets, long-term mortgages or notes payable and equity information. While these accounts may not necessarily be a focus for short-term purposes, a significant increase or decrease in these items can be a cause for concern in a company. Additionally, common size financial statements allow owners and managers the ability to compare their companies' financial statements to those of a competitor. By presenting both statements in percentage form, the comparison can quickly point out which company is weaker or stronger in certain areas.
