Financial Analysis: Comparative and Common Size Statements
Comparative Financial Statements
A comparative statement in accounting is a financial report that presents the same financial information for two or more reporting periods (e.g., this year vs. last year) side-by-side. This presentation format allows stakeholders like investors and managers to easily:
- Identify trends and patterns in financial performance or position.
- Track a company’s progress or regression over time.
- Calculate the absolute change (difference in currency amount) and percentage change for each line item, which is known as horizontal analysis.
Preparation of Comparative Financial Statements
The two most common comparative statements are the Comparative Income Statement and the Comparative Balance Sheet. The basic format for preparing both is similar.
1. Comparative Income Statement (Horizontal Analysis)
A comparative income statement compares revenues, expenses, and net income over multiple periods to analyze profitability trends.
| Particulars | Previous Year (Amount) | Current Year (Amount) | Absolute Change (Increase/Decrease) | Percentage Change |
|---|---|---|---|---|
| A. Revenue from Operations | XXX | YYY | (YYY – XXX) | (Absolute Change / Previous Year) × 100 |
| B. Less: Cost of Goods Sold | XXX | YYY | (YYY – XXX) | (Absolute Change / Previous Year) × 100 |
| C. Gross Profit (A-B) | XXX | YYY | (YYY – XXX) | (Absolute Change / Previous Year) × 100 |
| … continue with other items like Operating Expenses, Other Income/Expenses, and Net Income |
2. Comparative Balance Sheet (Horizontal Analysis)
A comparative balance sheet compares assets, liabilities, and equity at the end of multiple periods to analyze changes in the financial position over time.
| Particulars | Previous Year (Amount) | Current Year (Amount) | Absolute Change (Increase/Decrease) | Percentage Change |
|---|---|---|---|---|
| I. Equity and Liabilities | ||||
| 1. Shareholders’ Funds | ||||
| Share Capital | XXX | YYY | (YYY – XXX) | (Absolute Change / Previous Year) × 100 |
| 2. Non-Current Liabilities | ||||
| Long-term Borrowings | XXX | YYY | (YYY – XXX) | (Absolute Change / Previous Year) × 100 |
| … continue with Current Liabilities and Total Equity & Liabilities | ||||
| II. Assets | ||||
| 1. Non-Current Assets | ||||
| Fixed Assets (Tangible) | XXX | YYY | (YYY – XXX) | (Absolute Change / Previous Year) × 100 |
| 2. Current Assets | ||||
| Inventory | XXX | YYY | (YYY – XXX) | (Absolute Change / Previous Year) × 100 |
| … continue with other Current Assets and Total Assets |
Common Size Statements
A Common Size Statement is a vertical analysis technique used in financial statement analysis where each line item in a financial statement is expressed as a percentage of a base figure within the same statement.
- This technique is useful for internal comparisons (e.g., comparing performance across different periods) and external comparisons (e.g., comparing the company’s financial structure with its competitors or industry averages), regardless of the absolute size of the companies.
- By converting all amounts to percentages, the focus shifts from the absolute dollar value to the relative contribution or composition of each item.
Common Size Balance Sheet
In a Common Size Balance Sheet, every item is expressed as a percentage of the Total Assets (which is always equal to Total Liabilities and Equity).
Technique of Preparation
- Identify the Base Figure: The base figure is Total Assets (or Total Liabilities and Equity) for the period being analyzed. This figure is always assigned 100%.
- Calculate Percentage for Each Item: Each line item (e.g., Cash, Accounts Receivable, Inventory, Fixed Assets, Long-term Debt, Shareholders’ Equity, etc.) is divided by the Total Assets and multiplied by 100.
Interpretation
- It shows the composition of assets (how assets are distributed between current and non-current assets) and the structure of financing (the mix of debt and equity used to fund those assets).
- For example, if Inventory is 30% of Total Assets, it means 30 cents of every dollar of assets is tied up in inventory.
Common Size Income Statement
In a Common Size Income Statement, every item is expressed as a percentage of Net Sales (or Revenue from Operations).
Technique of Preparation
- Identify the Base Figure: The base figure is Net Sales (Revenue from Operations) for the period being analyzed. This figure is always assigned 100%.
- Calculate Percentage for Each Item: Every line item (e.g., Cost of Goods Sold, Operating Expenses, Gross Profit, Net Income, etc.) is divided by the Net Sales and multiplied by 100.
Interpretation
- It reveals the profitability relationships and the cost structure of the company.
- For example, if Cost of Goods Sold (COGS) is 60% of Net Sales, it means 60 cents of every dollar of sales is spent on acquiring or producing the goods sold. The remaining 40% is the Gross Profit margin.
Value Added Statement (VAS)
A Value Added Statement (VAS) is a financial report that focuses on the wealth created by a company through its collective activities (utilizing capital, labor, and capacity) during a specific period, and how that wealth is distributed among the various stakeholders.
It is considered a modified version of the Income Statement (Profit and Loss Account) but provides a much broader view of performance by focusing on wealth generation for all stakeholders, not just profit for shareholders.
Core Concept: Value Added (VA)
Value Added (VA) is the difference between the value of the output (sales revenue plus other income) and the cost of all goods and services purchased from outside the business (bought-in costs). The resulting value added represents the total wealth generated by the internal factors of production (employees, capital, and management).
Procedure for Preparing the Value Added Statement
A Value Added Statement is typically prepared in two main sections using a vertical (report) format: Generation of Value Added and Application (Distribution) of Value Added.
Part A: Calculation / Generation of Value Added
This section calculates the total wealth created by the business.
| Particulars | Amount ($) |
|---|---|
| A. Value of Output | |
| Sales Revenue (Net of VAT/GST) | XXX |
| Add: Other Operating Income (e.g., royalties, fees) | XX |
| Add/Less: Change in Stock (Finished Goods & Work-in-Progress) | (XX) |
| Total Value of Output | A |
| B. Less: Cost of Bought-in Materials and Services | |
| Materials Consumed (Raw Materials, Stores, Spares) | (XXX) |
| Outsourced Services (Audit fees, legal fees, consultation) | (XX) |
| Utilities (Electricity, water, communication) | (XX) |
| Total Bought-in Costs | (B) |
| Gross Value Added (GVA) | A – B |
| Less: Depreciation and Amortization | (XX) |
| Net Value Added (NVA) | XXX |
Part B: Application / Distribution of Value Added
This section shows how the calculated wealth (GVA or NVA) is distributed among the contributors/stakeholders. The total distribution must equal the total Value Added generated.
| Distribution to Stakeholders | Amount ($) |
|---|---|
| 1. To Employees (Labor) | |
| Salaries, Wages, Bonus, Pension Contributions, etc. | XXX |
| 2. To Providers of Capital (Financiers) | |
| Interest paid on loans/debentures (to creditors) | XX |
| Dividends paid (to shareholders/owners) | XX |
| 3. To Government (Society) | |
| Corporate Tax, Excise Duty, Customs, etc. | XX |
| 4. Retained in the Business (Reinvestment) | |
| Depreciation (for asset replacement/maintenance) | XX |
| Retained Earnings (Reserves for expansion/future needs) | XX |
| Total Distribution of Value Added | XXX |
Features and Advantages of Value Added Statements
Features of Value Added Statement
- Stakeholder-Oriented: It highlights the contribution of all factors of production and shows the reward distributed to each stakeholder (employees, government, financiers, and the company itself).
- Links to National Income: The total Value Added by all enterprises in an economy is a key component of the Gross Domestic Product (GDP) or Gross National Income (GNI).
- Simple Calculation: It is derived directly from the existing Profit and Loss Account data, making preparation straightforward.
- Non-Mandatory: In most countries, it is a voluntary supplemental statement, often used in Corporate Social Responsibility (CSR) reporting.
Advantages of Value Added Statement
- Improves Employee Morale: By clearly showing the wealth created and the share received by employees (wages, benefits), it can improve industrial relations and motivation.
- Broader Performance Measure: It serves as a superior measure of a firm’s size and economic importance compared to just sales or profit, especially for social accountability.
- Facilitates Comparison: It allows for fair comparison between companies of different sizes or in different industries, as the focus is on the relative distribution of wealth.
- Aids Management Decisions: Value Added Ratios (e.g., VA per employee, VA to Capital Employed) are useful diagnostic tools for assessing operational efficiency and productivity.
Limitations of the Value Added System
- Lack of Standardization: Since it is a voluntary report, there is no universally accepted format or accounting standard governing its presentation, leading to variations in how companies calculate and report VA.
- Supplement, Not Substitute: It does not replace the mandatory financial statements (Income Statement, Balance Sheet) and must be read in conjunction with them.
- Subjectivity in “Bought-in Costs”: What constitutes a “bought-in service” that should be deducted can sometimes be subjective, potentially affecting the calculated VA figure.
- Focus on Creation, Not Efficiency: The statement primarily shows how much wealth was created and distributed, but it doesn’t automatically show how efficiently the resources were used to generate that value, which requires further ratio analysis.