# Convert Balance Sheets to Common-size Balance Sheets

Converting a company’s balance sheet into a common-size balance sheet is a very useful tool for providing insight into a company’s liquidity as well as its solvency.

Common-sizing the balance sheet can assist with time-series analysis by comparing the company’s balance sheet composition over time. It can also assist with cross-sectional analysis by looking across companies in the same industry or sector. Indeed, the cross-sectional analysis may even highlight differences that exist between two or more companies’ strategies.

## Common-sizing the Balance Sheet

There are two primary methods for common-sizing the balance sheet: vertical common-size analysis, and horizontal common-size analysis.

The vertical common-size analysis involves stating each balance sheet item as a percentage of total assets, while the horizontal common-size analysis reflects quantities on the balance sheet in terms of a base-year value of choice. The vertical common-size analysis is, however, the more popular of the two methods.

### Example of a Vertical Common-size Analysis

$$\begin{array}{l|r|r} {} & \bf {\text{Dec }31,2016} & \bf{Common-} \\ \text{} & \bf{()} & \bf{size} \\ {} & {} & \bf{\text{balance-}} \\ \textbf{Assets} & {} & \bf{\text{sheet }(\%)} \\ \hline \text{Current Assets} & {} & {} \\ \hline {\quad \quad \text{Cash and cash equivalents}} & {100,000} & {0.8} \\ \hline {\quad \quad \text{Short-term marketable securities}} & {1,234,678} & {9.7} \\ \hline {\quad \quad \text{Accounts receivable}} & {52,000} & {0.4} \\ \hline {\quad \quad \text{Inventory}} & {1,170,356} & {9.2} \\ \hline \text{Total current assets} & {2,557,034} & {20.0} \\ \hline \text{Property, plant and equipment} & {6,834,190} & {53.6} \\ \hline \text{Intangible assets} & {3,370,041} & {26.4} \\ \hline \textbf{Total assets} & \bf{12,761,265} & \bf {100.0} \\ \hline \textbf{Liabilities and shareholders’ equity} & {} & {} \\ \hline \text{Current liabilities} & {} & {} \\ \hline {\quad \quad \text{Accounts payable}} & {3,825,396} & {30.0} \\ \hline \text{Total current liabilities} & {3,825,396} & {30.0} \\ \hline \text{Bonds payable} & {3,771,894} & {29.6} \\ \hline \text{Total liabilities} & {7,597,290} & {59.5} \\ \hline \text{Total shareholders’ equity} & {5,163,975} & {40.5} \\ \hline \textbf{Total liabilities and shareholders’ equity} & \bf {12,761,265} & \bf {100.0} \\ \end{array}$$

An analysis of data in the table above reveals that property, plant, and equipment, at 53.6%, make up the lion’s share of the company’s assets. The company does not have much cash and cash equivalents (0.8%), and most of its debt is in the form of accounts payable (30.0%). Also, there is no working capital as current assets (20.0%) is less than current liabilities (30.0%).

### Question 1

Which of the following statements is incorrect?

1. In a vertical common-size analysis, each balance sheet item is stated as a percentage of total assets.
2. A common-size analysis can be used to compare a company’s balance sheet composition over time.
3. A common-size analysis cannot assist with making a comparison across companies in the same industry.

Solution

Options A and B are accurate statements. However, option C is inaccurate because common-size analysis can, in fact, assist with making a comparison across companies in the same industry.

## Question 2

To convert a regular balance sheet into a common-size balance sheet, each line item is stated as a percentage of:

1. Total assets.
2. Total equity.
3. Total liabilities.

Solution

Making a common-size balance sheet requires stating each line item as a percentage of total assets.

Shop CFA® Exam Prep

Offered by AnalystPrep

Featured Shop FRM® Exam Prep Learn with Us

Subscribe to our newsletter and keep up with the latest and greatest tips for success

Sergio Torrico
2021-07-23
Excelente para el FRM 2 Escribo esta revisión en español para los hispanohablantes, soy de Bolivia, y utilicé AnalystPrep para dudas y consultas sobre mi preparación para el FRM nivel 2 (lo tomé una sola vez y aprobé muy bien), siempre tuve un soporte claro, directo y rápido, el material sale rápido cuando hay cambios en el temario de GARP, y los ejercicios y exámenes son muy útiles para practicar.
diana
2021-07-17
So helpful. I have been using the videos to prepare for the CFA Level II exam. The videos signpost the reading contents, explain the concepts and provide additional context for specific concepts. The fun light-hearted analogies are also a welcome break to some very dry content. I usually watch the videos before going into more in-depth reading and they are a good way to avoid being overwhelmed by the sheer volume of content when you look at the readings.
Kriti Dhawan
2021-07-16
A great curriculum provider. James sir explains the concept so well that rather than memorising it, you tend to intuitively understand and absorb them. Thank you ! Grateful I saw this at the right time for my CFA prep.
nikhil kumar
2021-06-28
Very well explained and gives a great insight about topics in a very short time. Glad to have found Professor Forjan's lectures.
Marwan
2021-06-22
Great support throughout the course by the team, did not feel neglected
Benjamin anonymous
2021-05-10
I loved using AnalystPrep for FRM. QBank is huge, videos are great. Would recommend to a friend
Daniel Glyn
2021-03-24
I have finished my FRM1 thanks to AnalystPrep. And now using AnalystPrep for my FRM2 preparation. Professor Forjan is brilliant. He gives such good explanations and analogies. And more than anything makes learning fun. A big thank you to Analystprep and Professor Forjan. 5 stars all the way!
michael walshe
2021-03-18
Professor James' videos are excellent for understanding the underlying theories behind financial engineering / financial analysis. The AnalystPrep videos were better than any of the others that I searched through on YouTube for providing a clear explanation of some concepts, such as Portfolio theory, CAPM, and Arbitrage Pricing theory. Watching these cleared up many of the unclarities I had in my head. Highly recommended.