Analysis of Financial Statements

Meaning of Financial Analysis

Objective

After going through this lesson, you shall be able to understand the following concepts.

Meaning of Financial Analysis

Objectives of Financial Analysis
Methods of Financial Analysis
Tools of Financial Analysis
Significance of Financial Analysis
Limitations of Financial Analysis

Meaning of Financial Analysis

Financial statements of a company represent the financial health and strength in terms of liquidity, profitability, stability and solvency. A
critical and thorough examination of the financial statements of a company in order to understand the data contained in it, is known as
'Financial Analysis'. Financial statements include both, income statements and balance sheet. Analysis of these statements helps in
studying the relationship between the different financial items. It helps in identifying and understanding the financial strengths and
weaknesses of a business. Financial Analysis not only include 'analysis' but also the 'interpretation' of financial data. Analysis and
interpretation of financial statements stands together. The one without other is of no relevance.

Financial Analyses not only establish cause and effect relationship among the various financial items but also present the financial data in
a proper manner. The main purpose of Analysis and Interpretation is to present the financial data in such a manner that is easily
understandable and self-explanatory. This helps the accounting users to assess the financial performance of the business over a period of
time. Moreover, Financial Analyses also facilitate the different accounting users in decision making and policy designing process.

Purposes/Objectives of Financial Analysis

The following are the objectives of the Financial analysis.

1. It enables the conduct of meaningful comparisons of financial data. It provides better and easy understanding of the changes in the financial data
overtime.
2. It helps in designing effective plans and better execution of plans by enabling control and checks over the use of the financial resources.
3. Analysis of Financial Statements helps to know the earning capacity and profitability of a business firm. It also measures the
efficiency of the business operations.
4. It also helps in assessing the solvency position of the firm. This implies that by studying the analysis of financial statements the
ability of a firm to discharge its short-term as well as long-term obligations (debts).
5. It enables the intra-firm as well as inter-firm comparison.
 6. It assists the management in decision making process, drafting various plans and to implement various cost effective measures.
7. It also helps in predicting the future trend and projected growth prospects of a business.

Methods of Financial Analysis

Analysis of financial statements can be done by any of the following methods.

a. External Analysis
b. Internal Analysis
c. Horizontal Analysis
d. Vertical Analysis

External Analysis

Analysis of financial statements by the external users is known as External Analysis. The external users include investors, creditors,
suppliers, government agencies, etc. These users do not enjoy the direct access to the books and financial records of a company. Hence,
they depend on the published reports, articles, magazines, government circulars, research papers, etc. to carry out their analysis.

Internal Analysis

Analysis of financial statements by the management and internal personnel is known as Internal Analysis. Unlike the external users, the
internal users such as owners, management, employees, etc enjoy direct access to the financial records of a company. Generally, these
users carry out financial analyses to judge the operational efficiency of the business and for effective decision making process.

Horizontal Analysis/Dynamic Analysis

It refers to the comparison of a financial item in the financial statements of one or more periods to its corresponding item in the base
accounting period. In other words, it is a comparison of financial items of different years (with the items of some selected base year).
Its main purpose is to determine the change in an item during an accounting period. The change in the item is expressed either in
absolute figures or in percentage or in both terms. It indicates growth or decline of the items of the financial statement. It is used for time
series analysis and is also known as Dynamic Analysis. Statements containing such analysis are termed as Comparative Financial
Statements.
Vertical Analysis/Static Analysis

It refers to the comparison of items of the financial statement to a common item of the same accounting period. Its purpose is to
determine the proportion of the items to the common item of the same accounting period. The change in the item is expressed either in
ratio or in percentage terms. It helps in predicting and determining the future relative proportion of an item to the common item. This
analysis provides the inter-firm as well as intra-firm comparison. This analysis is used for cross-sectional analysis and is also known as
Static Analysis. Statements containing such analysis are termed as Common Size Statements.

Difference between Horizontal Analysis and Vertical Analysis

Basis of
Horizontal Analysis Vertical Analysis
Difference
It refers to the comparison of an item of It refers to the comparison of item of the
the financial statement of one period or financial statement to the common item
Meaning
periods to its corresponding item of the of the same accounting period.
base accounting period.
Its purpose is to determine the change Its purpose is to determine the
in an item during an accounting period. proportion of item to the common item
Purpose The change in the item is expressed of the same accounting period. The
either in absolute figures or in change in the item is expressed either in
percentage or in both terms. ratio or in percentage terms.
It indicates growth or decline of the It helps in predicting and determining
Usefulness item. the future relative proportion of an item
to the common item.
It uses time series data (i.e. data of It uses cross-sectional data (i.e. data of
Type of Data
more than two years) one year)
It compares the same item of different It compares different items of the same
Items
accounting periods. accounting periods.
It is more reliable, as the data of more It is less reliable, as the data of a single
Reliability
than two accounting periods are used. accounting period is used.

Techniques/Tools of Financial Analysis

1. Comparative Statements- These statements depict the figures of two or more accounting years simultaneously that help to assess
the profitability and financial position of a business. The Comparative Statements help us in analysing the trend of the financial position of
the business. These financial statements enable comparisons of data of financial statements of two or more periods of a same enterprise or financial
statements of two or more enterprises. These statements express the absolute change and percentage change in the financial items over a period of time.
These statements uses horizontal analysis (dynamic analysis). The following are the commonly prepared Comparative Financial Statements.

Comparative Balance Sheet

Comparative Income Statement (or Statement of Profit and Loss)

2. Common Size Statements- These statements depict the relationship between various items of financial statements and some
common items (such as Revenue from Operations and the Total of Balance Sheet) in percentage terms. In other words, various items of
Statement of Profit and Loss such as Other Revenue, Cost of Materials Consumed, Purchases of Stock-in-Trade, Finance Costs, etc. are
expressed in terms of percentage of Revenue from Operations. On the other hand, different items of Balance Sheet such as Shareholders'
Funds, Non-Current Liabilities, Non-Current Assets, Current Assets, etc. are expressed in terms of percentage of Total of Balance Sheet.
These percentage figures are easily comparable with that of the previous years’ (i.e. inter-firm comparison) and with that of the figures of
other firms in the same industry (i.e. inter-firm comparison) as well. The following are the commonly prepared Common Size Financial
Statements.

Common Size Balance Sheet

Common Size Income Statement (or Statement of Profit and Loss)

3. Ratio Analysis- This technique depicts the relationship between various items of Balance Sheet and the Income Statements. It helps
in ascertaining the profitability, operational efficiency, solvency, etc of a firm. The analysis expresses financial items in terms of
percentage, fraction, proportion and as number of times. It enables budgetary controls by assessing the qualitative relationship among
different financial variables. This analysis provides vital information to different accounting users regarding the financial position, viability
and performance of a firm. It also facilitates decision making and policy designing process.

4. Cash Flow Analysis- This analysis is presented in the form of a statement showing inflows and outflows of cash and cash equivalents
from operating, investing and financing activities of a company during a particular period of time. It helps in analysing the reasons of
receipts and payments in cash and change in the cash balances during an accounting year in a company. It helps in depicting the cash
position of a particular organisation on a particular date.
Significance of Analysis of Financial Statements

Financial analysis helps in determining the financial position of a company. The analysis of financial statements are done by different
accounting users. While some of the accounting users are external such as creditors, government, tax authorities, investors, etc. (external
users), whereas, some users are internal such as owners, management, employees, etc, (internal users). Thus, it can be said that the
financial analysis caters the varying needs of different accounting users.

The following points explain the significance of the financial analysis to the various users.

1. Management- Analysis of financial statements helps the management in knowing different aspects of a business. It helps the
management in drafting various business policies and facilitate them in planning and decision making process. It also helps the
management in implementing various cost effective measures and control checks to eliminate the inefficiencies. Thus, financial
analysis helps the management to have clear view of the business efficiency.

2. Finance Manager- Financial analysis enables the company to understand its financial position and financial vitality. It helps in
knowing the earning capacity, profitability, solvency, stability and credit worthiness of the company. The finance manager is involved
in making different financing policies and determining the actual performance of the company. With the help of the financial analysis,
the finance manager take decisions whether to continue the existing policies, how to enhance efficiency of business operations, etc.

3. Creditors-With the help of the financial analysis, creditors can judge the ability of the business to discharge its all liabilities. Creditors
are basically interested in knowing the credit worthiness and liquidity position of a business. Financial analysis helps the creditors to
know the firm's capability to pay-off its debts over a period of time.

4. Lenders- Apart from judging the firm's ability to discharge its short-term debts on time, the financial analysis also helps in assessing
the long-term solvency. Lenders use financial analysis to evaluate the risk involved in lending funds to the firm and to calculate the
opportunity cost of the funds forwarded to the business.

5. Investors and Potential Investors- Investors and potential investors are those parties who either have invested or are planning to
invest in the business of a firm. These parties are usually interested in knowing the profitability and efficiency of the business.
Further, the financial analysis also helps the investors in evaluating the risk of investing by considering different investment
opportunities.

6. Employers- The employers of the firm are basically interested in the timely payment of the wages and salaries. With the help of
financial analysis they can judge the earnings and profitability of the business and can expect the reasonable hike or increment in
their salaries and wages.

7. Government- Financial analysis enables the government to formulate various policy measures. It also helps the government in
addressing the various macroeconomic problems such as unemployment, poverty, etc.

Limitations of Financial Analysis

The following points explain the various shortcomings of the financial analysis.
 1. Ignores Changes in the Price level- The financial analysis fails to capture the change in price level. The figures of different years
are taken on nominal values and not in real terms (i.e. not taking price change into considerations).

2. Misleading and Wrong Information- The financial analysis fails to reveal the change in the accounting procedures and practices.
Consequently they may provide wrong and misleading information.

3. Interim and Final Picture- The financial analysis presents only the interim report and thereby provides incomplete information.
They fail to provide the final and holistic picture.

4. Ignores Qualitative and Non-monetary Aspects- The financial analysis reveals only the monetary aspects. In other words, these
analyses consider only that information that can be expressed only in monetary terms. These analyses fail to disclose managerial
efficiency, growth prospects, and other non-operational efficiency of a business.

5. Accounting Concepts and Conventions- The financial analysis are based an accounting concepts and conventions. Therefore, the
analysis and conclusions based on such analyses may not be reliable. For example, suppose an accountant lays an analyse by
considering only the book-value of various items (i.e. according to the Going Concern Concept- valuing the items on the basis of their
original costs). In this case, the conclusions drawn by him will not be realistic as the present market value of the items are ignored.

6. Involves Personal Biasness- The financial analysis reflects the personal biasness and personal value judgments of the accountants
and experts involved. There are different techniques used by different personnel for charging depreciation (original cost or written-
down value method) and also for inventory valuation. The use of different techniques by different people reduces the effectiveness of
the financial analysis.

7. Unsuitable for Comparisons- Due to the involvement of personal value judgment, personal biasness and use of different
techniques by different accountants, various types of comparisons such as inter-firm and intra-firm comparisons may not be possible
and reliable.

Comparative Financial Statements

Objective

After going through this lesson, you shall be able to understand the following concepts.

Meaning of Comparative Financial Statements

Importance, Advantages and Disadvantages of Comparative Financial Statements
Format of Comparative Balance Sheet
Format of Comparative Income Statement

Introduction to Comparative Financial Statements

In the previous chapter, we learnt that the analysis of the financial statements is known as financial analysis. We also learnt about the
importance of the financial analysis and various tools to conduct such financial analyses. Comparative Financial Statements is one of the
many tools to analysis the financial statements of a company.

Definition

As the name suggests, Comparative Financial Statements involves a comparative analysis of various financial items recorded in the
financial statements (Statement of Profit and Loss and Balance Sheet). It represents the financial items of two different accounting periods
adjacent to each other and expresses any increase or decrease (in the monetary values of the financial items) both in the absolute as well
as percentage terms. That is, these statements help the accounting users to evaluate and assess the financial progress in relative terms.In
other words, these statements present the financial data in such a manner that it becomes very easy for the users to study and draw
conclusions without any ambiguity. Moreover, Comparative Financial Statements help the users to conduct different kinds of comparisons
such as intra-firm and inter-firm comparisons of financial statements over a period of time.

The following are the two Comparative Financial Statements that are commonly prepared.

1. Comparative Balance Sheet

2. Comparative Income Statements

Importance or Significance of Comparative Statements

1. Simple Presentation- The Comparative Statements present the financial data in a simpler form. Moreover, the year-wise data of
the same items are presented side-by-side, which not only makes the presentation clear but also enables easy comparisons (both
intra-firm and inter-firm) conclusive.

2. Easy for Drawing Conclusion- The presentation of comparative statement is so effective that it enables the analyst to draw
conclusion quickly and easily and that too without any ambiguity.

3. Easy to Forecast- The comparative analysis of profitability and operational efficiency of a business over a period of time helps in
analysing the trend and also assists the management to forecast and draft various future plans and policy measures accordingly.

4. Easy Detection of Problems- By comparing the financial data of two or more years, the financial management can easily detect
the problems. While comparing the data, some items may have increased, while others have decreased or remained constant. The
comparative analysis not only enables the management in locating the problems but also helps them to put various budgetary
controls and corrective measures to check whether the current performance is aligned with that of the planned targets.
Advantages of Comparative Statements

a. The side-by-side presentation of financial items not only makes the presentation clear but also enables easy comparisons (both intra-firm and inter-
firm) conclusive.
b. The presentation of comparative statement is so effective that it enables the analyst to draw conclusion quickly and easily and that too without any
ambiguity
c. The comparative analysis of profitability and operational efficiency of a business over a period of time enables the management to forecast and
draft various future plans.
d. The comparative analysis not only enables the management in locating the problems but also helps them to put various budgetary controls and
corrective measures to check whether the current performance is aligned with that of the planned targets.

Disadvantages of Comparative Statements

a. The most important disadvantage of Comparative Statements is that they fail to capture the effects of price change.
b. Further, these statements lead to misleading conclusions in case of changes in the accounting policies and accounting practices over the period of
study.
c. As these statements record the financial items at their original cost and not at their current market price, so they may lead to wrong and misleading
conclusions regarding the profitability and efficiency of the business

I. Comparative Balance Sheet

A balance sheet that presents shareholders' funds, values of assets, etc. of two or more accounting periods adjacent to each other (side-
by-side) is known as Comparative Balance Sheet. This statement facilitates comparisons of various financial items of two or more balance
sheets of an organisation. Such balance sheets help the users to analyse different changes and to evaluate the current performance in
relative to the past performances. The Comparative Balance Sheet also provides sufficient information to the accounting users to
understand the financial data and also to predict the future trends.

Comparative Balance Sheet as explained by Prof. Foulka, "Comparative Balance Sheet analysis is the study of the trend of the same
items, group of items and computed items in two or more balance sheets of the same business enterprise on different dates."

Format of Comparative Balance Sheet

The format of the Comparative Balance Sheet is explained diagrammatically below.

Performa of Comparative Balance Sheet

Comparative Balance Sheet

as on…..
Absolute Change Percentage Change
Previous Current
Particulars (Increase/Decrease) (Increase/Decrease)
Year Year
(Rs) (%)
I. Equity and Liabilities
1. Shareholders’ Funds
a. Equity Share Capital
b. Preference Share
Capital
c. Reserves and Surplus
2. Non-Current Liabilities
a. Long-Term
Borrowings
i. Secured Loans
ii. Unsecured Loans
b. Other Long-Term
Liabilities
3. Current Liabilities
a. Short-Term
 Borrowings
b. Trade Payables
c. Other Current
Liabilities
d. Short-Term
Provisions
Total *** *** *** ***

II. Assets
1. Non-Current Assets
a. Fixed Assets
i. Tangible Assets
ii. Intangible Assets
b. Non-Current
Investments
c. Long-Term Loans and
Advances
d. Other Non-Current
Assets
2. Current Assets
a. Inventories
b. Trade Receivables
c. Cash and Cash
Equivalents
d. Short-Term Loans and
Advances
e. Other Current Assets
Total ♦♦♦ ♦♦♦ ♦♦♦ ♦♦♦

The equality between (***) and (♦♦♦) ensures the arithmetical accuracy of the solution.

Example 1: From the following Balance Sheets of B2 Ltd., prepare a Comparative Balance Sheet as on March 31, 2012 and 2013.
 Balance Sheet
as on March 31, 2012 and 2013

Particulars Note No. 2012 2013

I. Equity and Liabilities
1. Shareholders’ Funds
(a) Equity Share Capital 2,00,000 2,40,000
(b) 10% Preference Share 1,00,000 1,00,000
Capital
(c) Reserves and Surplus 20,000 30,000
2. Non-Current Liabilities 1,50,000 2,00,000
3. Current Liabilities 80,000 70,000
Total 5,50,000 6,40,000

II. Assets
1. Non-Current Assets
(a) Fixed Assets 3,00,000 4,00,000
(b) Non-Current Investments 1,00,000 80,000
2. Current Assets 1,50,000 1,60,000
Total 5,50,000 6,40,000

Solution
Balance Sheet
as on March 31, 2012 and 2013
Absolute Percentage
Particulars 2012 2013 Change Change
(Rs) (%)
I. Equity and Liabilities
1. Shareholders’ Funds
(a) Equity Share Capital 2,00,000 2,40,000 40,000 20
(b) 10% Preference Share 1,00,000 1,00,000
- -
Capital
(c) Reserves and Surplus 20,000 30,000 10,000 50
2. Non-Current Liabilities 1,50,000 2,00,000 50,000 33.33
3. Current Liabilities 80,000 70,000 (10,000) (12.5)
Total 5,50,000 6,40,000 90,000 16.36
 II. Assets
1. Non-Current Assets
(a) Fixed Assets 3,00,000 4,00,000 1,00,000 33.33
(b) Non-Current Investments 1,00,000 80,000 (20,000) (20
)2. Current Assets 1,50,000 1,60,000 10,000 6.67
Total 5,50,000 6,40,000 90,000 16.36

Working Note:

Absolute Change = Current Years’ Figure (2013) – Previous Years’ Figure (2012)

For example, Absolute Change in Equity Share Capital = 2,40,000 – 2,00,000 = 40,000

Example 2: From the given below Balance Sheets of AKS Ltd., prepare a Comparative Balance Sheet as on March 31,2012 and 2013.

Particulars Note No. 2012 2013

I. Equity and Liabilities
1. Shareholders’ Funds
(a) Equity Share Capital 22,50,000 30,00,000
(b) Reserves and Surplus 6,00,000 4,50,000
2. Non-Current Liabilities
(a) Long-Term Borrowing 9,00,000 13,50,000
3. Current Liabilities
(a) Trade Payables (Creditors) 1,80,000 2,70,000
(b) Short-term provisions 1,20,000 1,80,000
Total 40,50,000 52,50,000

II. Assets
1. Non-Current Assets
 (a) Fixed Assets
(i) Tangible Assets 9,00,000 13,50,000
(ii) Intangible Assts 22,50,000 30,00,000
2. Current Assets
(a) Inventories 2,25,000 1,80,000
(b) Trade Receivables 3,00,000 4,50,000
(c) Cash and Cash Equivalents 3,75,000 2,70,000
Total 40,50,000 52,50,000

Solution
Comparative Balance Sheet
as on March 31, 2012 and 2013
Absolute Percentage
Particulars 2012 2013 Change Change
(Rs) (%)
I. Equity and Liabilities
1. Shareholders’ Funds
(a) Equity Share Capital 22,50,000 30,00,000 7,50,000 33.33
(b) Reserves and Surplus 6,00,000 4,50,000 (1,50,000) (25)
2. Non-Current Liabilities
(a) Long-Term 9,00,000 13,50,000 4,50,000 50
Borrowings
3. Current Liabilities
(a) Trade Payables 1,80,000 2,70,000 90,000 50
(Creditors)
(b) Short-Term Provisions 1,20,000 1,80,000 60,000 50
Total 40,50,000 52,50,000 12,00,000 29.63

II. Assets
1. Non-Current Assets
(a) Fixed Assets
(i) Tangible Assets 9,00,000 13,50,000 4,50,000 50
(ii) Intangible Assets 22,50,000 30,00,000 7,50,000 33.33
2. Current Assets
(a) Inventories 2,25,000 1,80,000 (45,000) (20)
(b) Trade Receivables 3,00,000 4,50,000 1,50,000 50
 (c) Cash and Cash 3,75,000 2,70,000 (1,05,000) (28)
Equivalents
Total 40,50,000 52,50,000 12,00,000 29.63

II. Comparative Income Statements

A Comparative Income Statement presents total revenue earned and expenses incurred by a business during an accounting period in
correspondence to the revenue and expenses incurred in the previous accounting period.That means, the revenues and expenses of two
different accounting periods are presented in a comparable form (side-by-side).

Format of Comparative Income Statement

A comparative income statement like comparative balance sheet also has five columns. The format of the Comparative Income Statement
is explained diagrammatically below.

Performa of Comparative Statement of Profit and Loss

Comparative Statement of Profit and Loss

Absolute Percentage
Previous Current
Particulars Change Change
Year Year
(Rs) (%)
I. Revenue from operations
 II. Other Incomes
Total Revenue (I + II)
Less: Expenses
Cost of Material Consumed
Purchase of Stock-in-Trade
Changes in Inventories of Finished
Goods
Work-in-Progress and Stock-in-
Trade
Employees Benefit Expenses
Finance Costs
Depreciation and Amortisation
Expenses
Other Expenses
Profit before Tax
Less: Tax
Profit after Tax

Example 1: From the following Statements of Profit and Loss of Fish Ltd., prepare a Comparative Statement of Profit and Loss for the year ended March
31, 2012 and 2013.

Particulars Note No. 2012 2013

Revenue from Operation 32,00,000 40,00,000
Cost of Material Consumed 16,00,000 20,00,000
Other Expenses 4,00,000 2,00,000
Tax Rate 35%

Solution
Comparative Statement of Profit and Loss
for the year ended March 31, 2012 and 2013

Absolute Percentage
Particulars 2012 2013 Change Change
(Rs) (%)
Revenue from Operations 32,00,000 40,00,000 8,00,000 25
Less: Expenses
 Cost of Material 16,00,000 20,00,000 4,00,000 25
Consumed
Other Expenses 4,00,000 2,00,000 (2,00,000) (50)
Profit before Tax 12,00,000 18,00,000 6,00,000 50
Less: Tax @ 35% 4,20,000 6,30,000 2,10,000 50
Profit after Tax 7,80,000 11,70,000 3,90,000 50

Working Notes:

Absolute Change = Current Years’ Figure – Previous Years’ Figure

Example 2: From the following Statements of Profit and Loss, prepare Comparative Statement of Profit and Loss for the year ended March 31, 2012 and
2013.
Statement of Profit and Loss

Particulars Note 2012 2013

No.
Revenue from Operations 5,00,000 7,50,000
Other Income 2,00,000 1,80,000
Employee Benefit Expenses 1,50,000 2,00,000
Stock-in-Trade 80,000 60,000
Depreciation 1,00,000 1,50,000
Tax Rate 50%

Solution

Comparative Statement of Profit and Loss

for the year ended March 31, 2012 and 2013

Absolute Percentage
Particulars 2012 2013 Change Change
(Rs) (%)
Revenue from Operations 5,00,000 7,50,000 2,50,000 50
Other Income 2,00,000 1,80,000 (20,000) (10)
 Total Revenue 7,00,000 9,30,000 2,30,000 32.86
Less: Expenses:
Employee Benefit 1,50,000 2,00,000 50,000 33.33
Expenses
Stock-in-Trade 80,000 60,000 (20,000) (25)
Depreciation 1,00,000 1,50,000 50,000 50
Expenses
Profit before Tax 3,70,000 5,20,000 1,50,000 40.54
Less: Tax @ 50% 1,85,000 2,60,000 75,000 40.54
Profit after Tax 1,85,000 2,60,000 75,000 40.54

Common Size Statements

Objective

After going through this lesson, you shall be able to understand the following concepts.

Meaning of Common Size Statements

Advantages and Disadvantages of Common Size Statements
Format of Common Size Balance Sheet
Format of Common Size Income Statement

Introduction to Common Size Statements

In the previous chapter, we learnt about the Comparative Financial Statements, where the data of the same financial items are placed
adjacently (side-by-side) and are compared. Besides, Comparative Financial Statements, there are many other tools of financial analysis
such as, Common Size Statements, Trend Analysis and Ratio Analysis. In this chapter, we are going to understand the meaning,
importance and procedures of preparing Common Size Statements and Trend Analysis.

Common Size Statements are the statements that depicts the relationship between various items of financial statements with some
common base in percentage terms. The Common Size Statements consist of two types of statements namely, Common Size Income
Statements (or Statement of Profit and Loss) and Common Size Balance Sheet. In case of Common Size Income Statements, the financial
items of Statement of Profit and Loss are expressed in terms of percentage of Revenue from Operations. On the other hand, in case of
Common Size Balance Sheet, the financial items of Balance Sheet are expressed in terms of percentage of Total of Balance Sheet. That is,
in other words, the common base is Revenue from Operations (in case of Common Size Income Statements) and Total of Balance Sheet
(in case of Common Size Balance Sheet). These percentage figures are easily comparable with that of the past years’ (i.e. inter-firm
comparison) and with that of the figures of other firms in the same industry (i.e. inter-firm comparison) as well. The analyses based on
these statements are commonly known as Vertical Analysis.

Advantages of Common Size Statements

 a. It helps in ascertaining the ratio of each item to a common item (Revenue from Operations and Total of Balance Sheet) of the financial statements
in terms of percentage.
b. It also helps in analysing the impact of each item on the operation and efficiency of the business.
c. It enables comparisons such as, inter-firm and intra-firm comparisons of liquidity, solvency and efficiency.

Disadvantages of Common Size Statements

a. These statements determine the proportion of each item to a common item rather than comparing the figures of the same item over a period of
time.
b. These statements enable only cross-sectional analysis of financial data.
Types of Common Size Statements
The following are commonly prepared Common Size Statements.
I. Common Size Balance Sheet
II.Common Size Income Statements

I. Common Size Balance Sheet

A Balance Sheet in which assets and liabilities are represented individually as a percentage of a common base is known as Common Size
Balance Sheet. In this statement, the common base is taken as the Total of Balance Sheet (i.e. total of equity and liabilities or total of
assets). The sum total of the Balance Sheet in percentage terms is assumed to be 100% and all equity and liabilities and assets are
expressed as a percentage of this total. For example, if Machinery is Rs 20,000 and the Total of Balance Sheet is Rs 4,00,000, then
Machinery is expressed as 5% of the Total of Balance Sheet

Format of Common Size Balance Sheet

A Common Size Balance Sheet consists of the following five columns.

 Common Size Balance Sheet
as on…..
Percentage of
Absolute Amount
Balance Sheet Total
Particulars Note No. Previous Current Previous Current
Year Year Year Year
(Rs) (Rs) (%) (%)
I. Equity and Liabilities
1. Shareholders’ Funds
a. Equity Share Capital
b. Preference Share Capital
c. Reserves and Surplus
2. Non-Current Liabilities
a. Long-Term Borrowings
i. Secured Loans
ii. Unsecured Loans
b. Other Long-Term Liabilities
3. Current Liabilities
a. Short-Term Borrowings
b. Trade Payables
c. Other Current Liabilities
 d. Short-Term provisions
Total

II. Assets
1. Non-Current Assets
a. Fixed Assets
i. Tangible Assets
ii. Intangible Assets
b. Non-Current Investments
c. Long-Term Loans and
Advances
d. Other Non-Current Assets
2. Current Assets
a. Inventories
b. Trade Receivables
c. Cash and Cash Equivalents
d. Short-Term Loans and
Advances
e. Other Current Assets
Total

Preparation of Common Size Balance Sheet

Step 1: Title of the Common Size Statement, i.e. ‘Common Size Balance Sheet’ is written at the top of the statement.
Step 2: In the ‘Particulars’ column, the various items of the Balance Sheet are shown under the headings of ‘Equity and Liabilities’ and ‘Assets’.
Step 3: In the ‘Absolute Amount’ column, amount of the items are shown in their respective ‘Year’ column to which they belong.
Step 4: The Equity and Liabilities and Assets are totalled and are shown separately for each year.
Step 5: In the ‘Percentage’ column, the percentage of each item in comparison to the Total of Balance Sheet are shown. The percentage share of each
item is calculated by the help of the following formula.
Example 1: Prepare Common Size Balance Sheet from the following data.

Particulars Note No. 2012 2013

I. Equity and Liabilities
1. Shareholders’ Funds
(a) Equity Share Capital 4,00,000 6,00,000
(b) Reserves and Surplus 1,00,000 1,50,000
2. Non-Current Liabilities
(a) Long-Term Borrowings 3,00,000 3,20,000
3. Current Liabilities
(a) Trade Payables 2,00,000 2,50,000
Total 10,00,000 13,20,000

II. Assets
1. Non-Current Assets
(a) Fixed Assets
(i) Tangible Assets 5,00,000 6,75,000
(ii) Intangible Assets 1,00,000 1,20,000
(b) Non-Current Investments 1,50,000 2,00,000
2. Current Assets 2,50,000 3,25,000
Total 10,00,000 13,20,000

Solution
Common Size Balance Sheet
as on….
Percentage of
Absolute Amount
Balance Sheet Total
Particulars Note No.
2012 2013 2012 2013
(Rs) (Rs) (%) (%)
I. Equity and Liabilities
 1. Shareholders’ Funds
(a) Equity Share Capital 4,00,000 6,00,000 40 45.45
(b) Reserves and Surplus 1,00,000 1,50,000 10 11.36
2. Non-Current Liabilities
(a) Long-Term Borrowings 3,00,000 3,20,000 30 24.24
3. Current Liabilities
(a) Trade Payables 2,00,000 2,50,000 20 18.94
Total 10,00,000 13,20,000 100 100

II. Assets
1. Non-Current Assets
(a) Fixed Assets
(i) Tangible Assets 5,00,000 6,75,000 50 51.14
(ii) Intangible Assets 1,00,000 1,20,000 10 9.09
(b) Non-Current 1,50,000 2,00,000 15 15.15
Investments
2. Current Assets 2,50,000 3,25,000 25 24.62
Total 10,00,000 13,20,000 100 100

Working Note:

For example,

Example 2: Prepare Common Size Balance Sheet of Rambo Ltd. as on March 31, 2012 and 2013, as per Revised Schedule VI.
Rambo Ltd.
 Balance Sheet
as at 31 March 2012 and 2013

Particulars Note No. 2012 2013

I. Equity and Liabilities
1. Shareholders’ Funds
(a) Equity Share Capital 2,00,000 3,00,000
(b) Reserves and Surplus 3,00,000 4,00,000
2. Non-Current Liabilities
(a) Long-Term Borrowings 5,00,000 3,00,000
3. Current Liabilities
(a) Trade Payables 1,50,000 2,00,000
(b) Short-Term Provision 50,000 3,00,000
Total 12,00,000 15,00,000

II. Assets
1. Non-Current Assets
(a) Fixed Assets
(i) Tangible Assets 4,00,000 6,00,000
(b) Non-Current Investments 2,00,000 3,00,000
2. Current Assets
Trade Receivables 5,00,000 4,00,000
Cash and Cash Equivalent 1,00,000 2,00,000
Total 12,00,000 15,00,000

Solution
Rambo Ltd.
Balance Sheet
as on 31 March 2012 and 2013

Percentage of
Absolute Amount
Balance Sheet Total
Particulars Note No.
2012 2013 2012 2013
(Rs) (Rs) (%) (%)
I. Equity and Liabilities
1. Shareholders’ Funds
 (a) Equity Share Capital 2,00,000 3,00,000 16.67 20
(b) Reserve and Surplus 3,00,000 4,00,000 25 26.67
2. Non-Current Liabilities
(a) Long term borrowings 5,00,000 3,00,000 41.67 20
3. Current Liabilities
(a) Trade Payable 1,50,000 2,00,000 12.50 13.33
(b)Short Term Provision 50,000 3,00,000 4.17 20
Total 12,00,000 15,00,000 100 100

II. Assets
1. Non-Current Assets
(a) Fixed Assets
(i) Tangible Assets 4,00,000 6,00,000 33.33 40
(b) Non-Current 2,00,000 3,00,000 16.67 20
Investments
2. Current Assets
Trade and Receivable 5,00,000 4,00,000 41.67 26.67
Cash and Cash Equivalent 1,00,000 2,00,000 8.33 13.33
Total 12,00,000 15,00,000 100 100

II. Common Size Income Statement

Common Size Income Statement is defined as an income statement in which all the items of revenues and expenses are expressed as a
percentage of Revenue from Operations as the common base. The figure of Revenue from Operations is assumed to be 100 and all
revenues and expenses items are expressed in percentage terms as a proportion of Revenue from Operations.

Format of Common Size Income Statement

A Common Size Income Statement consists of the following five columns.

 Common Size Statement of Profit and Loss
for the year ended...
Percentage of Revenue
Absolute Amount
from Operations
Particulars Previous Current Previous Current
Year Year Year Year
(Rs) (Rs) (%) (%)
I. Revenue from Operations
II. Other Income
Total Revenue (I + II)
Less: Expenses
Cost of Material Consumed
Purchase of Stock-in-Trade
Changes in Inventories of Finished
Goods,
Work-in-Progress and Stock-in-
Trade
Employees Benefit Expenses
Finance Costs
Depreciation and Amortization
Expenses
Other Expenses
 Profit before Tax
Less: Tax
Profit after Tax

Preparation of Common Size Statement of Profit and Loss

Step 1: Title of the Common Size Statement, i.e. ‘Common Size Statement of Profit and Loss’ is written at the top of the statement.
Step 2: In the ‘Particulars’ column, the various items of Statement of Profit and Loss are shown under their respective heads.
Step 3: In the ‘Absolute Amount’ column, amount of the items are shown in their respective ‘Year’ column to which they belong.
Step 4: In the ‘Percentage’ column, the percentage of each item in comparison to the Revenue from Operations are shown. The percentage share of each
item is calculated by the help of the following formula.

Example 1: Prepare a Common Size Statement of Profit and Loss from the given below data.

Particulars 2011 2012

(Rs) (Rs)
Revenue from Operations 1,00,000 1,25,000
Cost of Material Consumed 65,000 80,000
Employee Benefit Expenses 6,000 10,000
Other Expenses 7,000 9,000
Other Income 12,000 15,000
Tax Rate 35% 40% 40%

Solution
Common Size Statement of Profit and Loss
for the year ended March 31, 2011 and 2012

Percentage of Revenue
Absolute Amount
from Operations
Particulars
2011 2012 2011 2012
(Rs) (Rs) (%) (%)
 I. Revenue from Operations 1,00,000 1,25,000 100 100
II. Other Income 12,000 15,000 12 12
Total Revenue (I + II) 1,12,000 1,40,000 112 112
Less: Expenses:
Cost of Material 65,000 80,000 65 64
Consumed
Employees Benefit cost 6,000 10,000 6 8
Other Expenses 7,000 9,000 7 7.2
Profit before Tax 34,000 41,000 34 32.8
Less: Tax @ 40% 13,600 16,400 13.6 13.12
Profit after Tax 20,400 24,600 20.4 19.68

Working Note:

For example,

Example 2: Prepare a Common Size Statement of Profit and Loss for Rocky Ltd. from the data given below.

2011 2012
Particulars
(Rs) (Rs)
Revenue from Operations 4,00,000 5,00,000
Purchases 2,00,000 3,00,000
Depreciation and Amortisation Expenses 20,000 30,000
Changes in Inventories of Finished Goods
and Work-in-Progress 50,000 80,000
 Finance Costs 20,000 40,000
Tax Rate 50% 60%

Solution
Rocky Ltd.
Common Size Statement of Profit and Loss
Percentage of
Absolute Amount Revenue from
Particulars Operations
2011 2012 2011 2012
(Rs) (Rs) (%) (%)
I. Revenue from Operations 4,00,000 5,00,000 100 100
Less: Expenses
Purchase of Stock-in-Trade 2,00,000 3,00,000 50 60
Changes in Inventories to
Finished
Goods and Work-in-Progress 50,000 80,000 12.5 16
Finance Costs 20,000 40,000 5 8
Depreciation and Amortisation 20,000 30,000 5 6
Expenses
Profit before Tax 1,10,000 50,000 27.50 10
Less: Tax 55,000 30,000 13.75 6
Profit after Tax 55,000 20,000 13.75 4

Topics

Meaning of Financial Analysis

Comparative Financial Statements
Common Size Statements