Basic Financial Statement Anaylsis


Objective 5: Describe techniques of percentage analysis.

PERCENTAGE (COMMON SIZE) ANALYSIS

Analysts also use percentage analysis to help them evaluate and compare companies. Percentage analysis consists of reducing a series of related amounts to a series of percentages of a given base. All items in an income statement are frequently expressed as a percentage of sales or sometimes as a percentage of cost of goods sold. A balance sheet may be analyzed on the basis of total assets. This analysis facilitates comparison and is helpful in evaluating the relative size of items or the relative change in items. A conversion of absolute dollar amounts to percentages may also facilitate comparison between companies of different size. To illustrate, here is a comparative analysis of the expense section of Anetek for the last 2 years.


Illustration 8: Horizontal Percentage Analysis


Anetek Chemical

 

2002

2001

Difference

% Change
Inc.(Dec.)

Cost of Sales $1,000.0 $ 850.0 $ 150.0 17.6
Depreciation and amortization 150.0 150.0 0 0
Selling and administrative expenses 225.0 150.0 75.0 50.0
Interest expense 50.0 25.0 25.0 100.0
Taxes 100.0 75.0 25.0 33.3

This approach, normally called horizontal analysis, indicates the proportionate change over a period of time. It is especially useful in evaluating a trend situation, because absolute changes are often deceiving.

Another approach, called vertical analysis, is the proportional expression of each item on a financial statement in a given period to a base figure. For example, Anetek Chemical's income statement using this approach appears below.

Illustration 9: Vertical Percentage Analysis

Anetek Chemical
INCOME STATEMENT
(000,000 omitted)
Net Sales $1,600.0 96%
Other revenue       75.0           4
Total revenue 1,675.0     100
Less    
    Cost of goods sold 1,000.0 60
    Depreciation and amortization 150.0 9
    Selling and administrative expenses 225.0 13
    Interest expense 50.0 3
    Income tax 100.0 6
        Total expenses 1,525.0         91
Net income $ 150.0 9%
  ======= =======

Reducing all the dollar amounts to a percentage of a base amount is frequently called common-size analysis because all of the statements and all of the years are reduced to a common size; that is, all of the elements within each statement are expressed in percentages of some common number and always add up to 100 percent. Common-size (Percentage) analysis is the analysis of the composition of each of the financial statements.

In the analysis of the balance sheet, common-size analysis answers such questions as: What is the distribution of equities between current liabilities, long-term debt, and owners' equity? What is the mix of assets (percentage-wise) with which the enterprise has chosen to conduct its business? What percentage of current assets are in inventory, receivables, and so forth?

The income statement lends itself to common-size analysis because each item in it is related to a common amount, usually sales. It is instructive to know what proportion of each sales dollar is absorbed by various costs and expenses incurred by the enterprise.

Common-size statements may be used for comparing one company's statements from different years to detect trends not evident from the comparison of absolute amounts. Also, common-size Statements provide intercompany comparisons regardless of size because the financial statements can be recast into a comparable common-size format.