1.1 Common-size Financial Statements Flashcards
(6 cards)
In financial statement analysis, expressing all financial statement items as a percentage of base-year amounts is called
A. Horizontal common-size analysis.
B. Vertical common-size analysis.
C. Variance analysis.
D. Ratio analysis.
A. Horizontal common-size analysis.
Expressing financial statement items as percentages of corresponding base-year figures is a horizontal form of common-size (percentage) analysis that is useful for evaluating trends. The base amount is assigned the value of 100%, and the amounts for other years are denominated in percentages compared to the base year.
In assessing the financial prospects for a firm, financial analysts use various techniques. An example of vertical, common-size analysis is
A. An assessment of the relative stability of a firm’s level of vertical integration.
B. A comparison in financial ratio form between two or more firms in the same industry.
C. Advertising expense is 2% greater compared with the previous year.
D. Advertising expense for the current year is 2% of sales.
D. Advertising expense for the current year is 2% of sales.
Vertical, common-size analysis compares the components within a set of financial statements. A base amount is assigned a value of 100%. For example, total assets on a common-size balance sheet and net sales on a common-size income statement are valued at 100%. Common-size statements permit evaluation of the efficiency of various aspects of operations. An analyst who states that advertising expense is 2% of sales is using vertical, common-size analysis.
The dollar value of a company’s ending inventory on its balance sheet was $500,000, $600,000, and $400,000 for Years 1,2, and 3, respectively. In preparing a horizontal analysis with Year 1 as the base year, the percentage change shown for Year 3 would be
A. (25%)
B. (20%)
C. 20%
D. 80%
B. (20%)
Purpose of common-size financial statements
Common-size financial statements restate financial statement line items in terms of percentages of a given amount so that the financial statements of steadily growing firms and firms of different sizes can be analyzed and compared
A financial analyst is reviewing a competitor’s income statements for the past 2 years.
Year 1 & Year 2
Sales £250,000 & £275,000
Cost of goods sold 155,000 & 160,000
Gross profit 95,000 & 115,000
Selling expenses 35,000 & 40,000
General expenses 45,000 & 50,000
Operating income before income taxes 15,000 & 25,000
Taxes related to operations 2,500 & 3,500
Net income £ 12,500 & £ 21,500
The financial analyst is able to conclude that the competitor’s
A. Common size income statements will show taxes related to operations at 16% for Year 2.
B. Common base year income statements will show that gross profit increased by 17% in Year 2 as compared to Year 1.
C. Common base year income statements will show that selling expenses increased by 14% in Year 2 as compared to Year 1.
D. Common size income statements will show operating income before income taxes at 22% for Year 2.
C. Common base year income statements will show that selling expenses increased by 14% in Year 2 as compared to Year 1.
Selling expenses went from £35,000 in Year 1 to £40,000 in Year 2. Relative to Year 1 selling expenses, the selling expenses increased 14% in Year 2 {[(£40,000 – £35,000) ÷ £35,000] = 0.14 (rounded)}.
Select information from a company’s year-end balance sheet is shown below.
Balance Sheet
As of December 31, Year 1
Cash $ 50,000
Accounts receivable 120,000
Inventory 75,000
Property, plant and equipment, net 250,000
Total assets $495,000
Accounts payable $ 35,000
Long-term debt 100,000
Total liabilities 135,000
Common stock 300,000
Retained earnings 60,000
Total equity 360,000
Total liabilities and equity $495,000
Based on the above information, a common-size balance sheet for the company will show
A. Retained earnings at 17%.
B. Property, plant and equipment, net at 69%.
C. Accounts receivables at 24%.
D. Long-term debt at 74%.
C. Accounts receivables at 24%.
Items on common-size financial statements are expressed as percentages of total assets on the balance sheet. Thus, the company will record accounts receivables at 24% ($120,000 ÷ $495,000) on a common-size balance sheet.
