{"id":46916,"date":"2023-09-27T06:11:39","date_gmt":"2023-09-27T06:11:39","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=46916"},"modified":"2026-04-20T08:40:28","modified_gmt":"2026-04-20T08:40:28","slug":"common-size-balance-sheet-and-related-financial-ratios","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/financial-reporting-and-analysis\/common-size-balance-sheet-and-related-financial-ratios\/","title":{"rendered":"Common-size Balance Sheet and Related Financial Ratios"},"content":{"rendered":"\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"VideoObject\",\n  \"name\": \"Analyzing Balance Sheets (2024\/2025 CFA\u00ae Level I Exam \u2013 FSA \u2013 Learning Module 3)\",\n  \"description\": \"This CFA\u00ae Level I Financial Statement Analysis lesson focuses on analyzing balance sheets for exam-ready interpretation. The video explains how to assess liquidity, solvency, and financial flexibility using balance sheet data, including common-size analysis and key ratios. It covers accounting treatments for intangible assets and goodwill, IFRS versus US GAAP differences in R&D capitalization, cost versus revaluation models, and impairment. The lesson also addresses classification and measurement of financial instruments, non-current liabilities at amortized cost, deferred tax liabilities, and practical balance sheet adjustments analysts make in real-world and exam scenarios, reinforced with practice problems throughout.\",\n  \"uploadDate\": \"2023-11-01\",\n  \"thumbnailUrl\": \"https:\/\/img.youtube.com\/vi\/pHobAPJRRAo\/hqdefault.jpg\",\n  \"contentUrl\": \"https:\/\/www.youtube.com\/watch?v=pHobAPJRRAo\",\n  \"embedUrl\": \"https:\/\/www.youtube.com\/embed\/pHobAPJRRAo\",\n  \"duration\": \"PT30M15S\"\n}\n<\/script>\n\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"@id\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/financial-reporting-and-analysis\/common-size-balance-sheet-and-related-financial-ratios\/#qa-q1\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"The current ratio for company XYZ is closest to:\",\n    \"text\": \"The following balance sheet information is given for company XYZ. The current ratio for company XYZ is closest to:\\nA. 0.34\\nB. 0.67\\nC. 1.20\",\n    \"answerCount\": 1,\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"B. 0.67. Current ratio = Current assets \/ Current liabilities = 2,557,034 \/ 3,825,396 \u2248 0.67.\",\n      \"dateCreated\": \"2026-01-13\",\n      \"url\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/financial-reporting-and-analysis\/common-size-balance-sheet-and-related-financial-ratios\/\"\n    }\n  }\n}\n<\/script>\n<!-- QAPage Schema (Question 2) -->\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"@id\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/financial-reporting-and-analysis\/common-size-balance-sheet-and-related-financial-ratios\/#qa-q2\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"To convert a regular balance sheet into a common-size balance sheet, each line item is stated as a percentage of:\",\n    \"text\": \"To convert a regular balance sheet into a common-size balance sheet, each line item is stated as a percentage of:\\nA. Total assets.\\nB. Total equity.\\nC. Total liabilities.\",\n    \"answerCount\": 1,\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"A. Total assets. A common-size balance sheet states each line item as a percentage of total assets.\",\n      \"dateCreated\": \"2026-01-13\",\n      \"url\": \"https:\/\/analystprep.com\/cfa-level-1-exam\/financial-reporting-and-analysis\/common-size-balance-sheet-and-related-financial-ratios\/\"\n    }\n  }\n}\n<\/script>\n\n\n\n<iframe loading=\"lazy\" width=\"560\" height=\"315\" src=\"https:\/\/www.youtube.com\/embed\/pHobAPJRRAo?si=6fUUetpykEPcZbqz\" title=\"YouTube video player\" frameborder=\"0\" allow=\"accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture; web-share\" referrerpolicy=\"strict-origin-when-cross-origin\" allowfullscreen><\/iframe>\n\n\n\n<p>Examining a company&#8217;s balance sheet can reveal information about its liquidity and solvency at the time the balance sheet is prepared, as well as the economic resources under the company&#8217;s control. Recall that liquidity is defined as the company\u2019s ability to meet its short-term financial commitments. In other words, analysis of liquidity concentrates on the company&#8217;s ability to liquidate assets into cash to cover operating expenses.<\/p>\n\n\n\n<p>On the other hand, solvency refers&nbsp;to a company\u2019s ability to meet its financial obligations over the longer term. As such, solvency emphasizes the company&#8217;s financial framework and its capacity to service long-term debts.<\/p>\n\n\n\n<p>The main tools of analyzing balance sheets are common-size analysis and balance sheet ratios.<\/p>\n\n\n\n<div style=\"background-color:#f5f7fa; padding:20px; text-align:center; margin:30px 0; border-radius:8px;\">\n  <div style=\"max-width:620px; margin:0 auto;\">\n    <a href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\"\n       style=\"display:flex; align-items:center; justify-content:center; width:100%; padding:10px 20px; border:2px solid #1a73e8; border-radius:999px; text-decoration:none; color:#1a73e8; font-size:15px; font-weight:600; line-height:1.4;\">\n      Practice balance sheet ratios with our Free Trial\n    <\/a>\n  <\/div>\n<\/div>\n\n\n<h2>Common-Sizing the Balance Sheet<\/h2>\n<p>Common-size balance sheets are valuable for analyzing the composition of a company&#8217;s balance sheet both over time (time-series analysis) and in comparison with other companies within the same industry (cross-sectional analysis).<\/p>\n<p>Two primary methods for common-sizing the balance sheet are vertical common-size analysis and horizontal common-size analysis.<\/p>\n<p>The vertical common-size analysis states each balance sheet item as a percentage of total assets. In contrast, the horizontal common-size analysis reflects quantities on the balance sheet regarding a base-year value of choice. However, the vertical common-size analysis is the more popular of the two methods.<\/p>\n<h4><strong>Example: Vertical Common-size Analysis (Time-Series Analysis)<\/strong><\/h4>\n<p>$$ \\begin{array}{l|r|r}<br \/>&amp;\u00a0 &amp; \\textbf{Common\u2212} \\\\<br \/>&amp; &amp; \\textbf{size} \\\\<br \/>&amp;\\textbf{Dec 31, 2016} &amp; \\textbf{balance-} \\\\<br \/>\\textbf{Assets}&amp; \\textbf{(\\$)} &amp; {\\textbf{sheet (%)} } \\\\ \\hline<br \/>\\text{Current Assets} &amp; &amp; \\\\ \\hline<br \/>\\text{Cash and cash equivalents} &amp; 100,000 &amp; 0.8 \\\\ \\hline<br \/>\\text{Short-term marketable securities} &amp; 1, 234,678 &amp; 9.7 \\\\ \\hline<br \/>\\text{Accounts receivable} &amp; 52,000 &amp; 0.4 \\\\ \\hline<br \/>\\text{Inventory} &amp; 1, 170,356 &amp; 9.2 \\\\ \\hline<br \/>\\text{Total current assets} &amp; 2, 557,034 &amp; 20.0 \\\\ \\hline<br \/>\\text{Property, plant, and equipment} &amp; 6, 834,190 &amp; 53.6 \\\\ \\hline<br \/>\\text{Intangible assets} &amp; 3, 370,041 &amp; 26.4 \\\\ \\hline<br \/>\\text{Total assets} &amp; 12, 761,265 &amp; 100.0 \\\\ \\hline<br \/>\\text{Liabilities and shareholders&#8217; equity} &amp; &amp; \\\\ \\hline<br \/>\\text{Current liabilities} &amp; &amp; \\\\ \\hline<br \/>\\text{Accounts payable} &amp; 3, 825,396 &amp; 30.0 \\\\ \\hline<br \/>\\text{Total current liabilities} &amp; 3, 825,396 &amp; 30.0 \\\\ \\hline<br \/>\\text{Bonds payable} &amp; 3, 771,894 &amp; 29.6 \\\\ \\hline<br \/>\\text{Total liabilities} &amp; 7, 597,290 &amp; 59.5 \\\\ \\hline<br \/>\\text{Total shareholders&#8217; equity} &amp; 5, 163,975 &amp; 40.5 \\\\ \\hline<br \/>{\\text{Total liabilities and shareholders&#8217;} \\\\ \\text{equity}} &amp; 12, 761,265 &amp; 100.0<br \/>\\end{array} $$<\/p>\n<p>An analysis of data in the table above reveals that property, plant, and equipment, at 53.6%, make up the lion&#8217;s share of the company&#8217;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%) are less than current liabilities (30.0%).<\/p>\n<h4><strong>Example: Vertical Common-size Analysis (Cross-Sectional Analysis Analysis)<\/strong><\/h4>\n<p>Emma Stone is analyzing two companies in the electronics industry to assess their financial health as shown on their balance sheets. She has prepared the following vertical common-size balance sheets for Sony and Panasonic (hypothetical values):<\/p>\n<p>$$\\begin{array}{l|c|c}<br \/>\\hline &amp; \\textbf{Sony} &amp; \\textbf{Panasonic} \\\\ \\hline<br \/>\\textbf{ASSETS:} &amp; \\textbf{31 March 2023} &amp; \\textbf{31 March 2023} \\\\ \\hline<br \/>\\text{Current assets:} &amp; &amp; \\\\<br \/>\\text{Cash and cash equivalents} &amp; 6.2 &amp; 4.5 \\\\<br \/>\\text{Short-term marketable securities} &amp; 12.7 &amp; 48.0 \\\\<br \/>\\text{Accounts receivable} &amp; 5.3 &amp; 9.1 \\\\<br \/>\\text{Inventories} &amp; 1.5 &amp; 1.2 \\\\<br \/>\\text{Other current assets} &amp; 3.9 &amp; 2.5 \\\\<br \/>\\textbf{Total current assets} &amp; 29.6 &amp; 65.3 \\\\<br \/>\\text{Long-term marketable securities} &amp; 47.1 &amp; 3.0 \\\\<br \/>\\text{Property, plant, and equipment, net} &amp; 10.2 &amp; 10.5 \\\\<br \/>\\text{Goodwill} &amp; 2.0 &amp; 15.2 \\\\<br \/>\\text{Acquired intangible assets, net} &amp; 0.8 &amp; 4.5 \\\\<br \/>\\text{Other assets} &amp; 25.3 &amp; 2.9 \\\\<br \/>\\textbf{Total assets} &amp; 100.0 &amp; 100.0 \\\\<br \/>\\text{LIABILITIES AND SHAREHOLDERS&#8217;}\\\\<br \/>\\text{EQUITY:} &amp; &amp; \\\\<br \/>\\text{Current liabilities:} &amp; &amp; \\\\<br \/>\\text{Accounts payable} &amp; 14.0 &amp; 3.5 \\\\<br \/>\\text{Short-term debt} &amp; 3.5 &amp; 4.0 \\\\<br \/>\\text{Current portion of long-term debt} &amp; 1.8 &amp; 0.5 \\\\<br \/>\\text{Accrued expenses} &amp; 7.2 &amp; 2.9 \\\\<br \/>\\text{Deferred revenue} &amp; 2.1 &amp; 13.5 \\\\<br \/>\\text{Other current liabilities} &amp; 0.0 &amp; 2.7 \\\\<br \/>\\textbf{Total current liabilities} &amp; 28.6 &amp; 27.1 \\\\<br \/>\\text{Long-term debt} &amp; 26.5 &amp; 32.4 \\\\<br \/>\\text{Deferred revenue non-current} &amp; 0.9 &amp; 4.6 \\\\<br \/>\\text{Other non-current liabilities} &amp; 11.2 &amp; 7.5 \\\\<br \/>\\textbf{Total liabilities} &amp; 67.2 &amp; 71.6 \\\\<br \/>\\textbf{Total shareholders&#8217; equity} &amp; 32.8 &amp; 28.4 \\\\<br \/>\\textbf{Total liabilities and shareholders&#8217;}&amp;&amp;\\\\<br \/>\\textbf{equity} &amp; 100.0 &amp; 100.0 \\\\<br \/>\\hline<br \/>\\end{array}$$<\/p>\n<p>Based on the common-size balance sheet data for Sony and Panasonic, what insights can be drawn about the liquidity, cash, and marketable securities, accounts receivable, inventories, and capital structure of these two companies?<\/p>\n<p><strong>Solution<\/strong><\/p>\n<p><strong>Liquidity<\/strong>: Both companies have a significant portion of their assets in current assets, indicating liquidity. Sony has 29.6% of its assets in current assets, while Panasonic has a higher proportion at 65.3%. This suggests that Panasonic might have a better ability to meet short-term obligations compared to Sony.<\/p>\n<p><strong>Cash and Marketable Securities<\/strong>: Sony has a higher percentage of cash and cash equivalents (6.2%) compared to Panasonic (4.5%). However, Sony has a lower allocation in short-term marketable securities (12.7%) than Panasonic (48.0%). This indicates that Panasonic is holding more liquidity in cash, while Sony is investing more in short-term securities.<\/p>\n<p><strong>Accounts Receivable<\/strong>: Panasonic has a higher percentage of accounts receivable (9.1%) compared to Sony (5.3%), which could imply that Panasonic extends more credit to its customers or takes longer to collect payments.<\/p>\n<p><strong>Inventories<\/strong>: Both companies have a small portion of their assets in inventories, with Sony at 1.5% and Panasonic at 1.2%, suggesting efficient inventory management.<\/p>\n<p><strong>Capital Structure<\/strong>: The total liabilities to total assets ratio differs between the two companies, with Sony having 67.2% and Panasonic having 71.6%. This indicates that Panasonic has a higher level of leverage compared to Sony, suggesting a greater reliance on debt financing in its capital structure.<\/p>\n<p><strong>Shareholders&#8217; Equity<\/strong>: Sony has a slightly higher proportion of shareholders&#8217; equity (32.8%) compared to Panasonic (28.4%), suggesting that Sony has a slightly stronger equity position.<\/p>\n<h2>Balance Sheet Ratios<\/h2>\n<p>Ratio analysis can assist with the conduct of time series and cross-sectional analysis of a company&#8217;s financial position.Balance sheet ratios are those ratios that involve balance sheet items only. In a vertical common-size balance sheet, each line item represents a ratio, as it expresses a balance sheet figure as a percentage of total assets. Additionally, other balance sheet ratios are used to compare one balance sheet item to another.<\/p>\n<p>Balance ratios are classified into: (i) liquidity ratios, which measure a company&#8217;s ability to meet short-term obligations; and (ii) solvency ratios, which measure financial risk, financial leverage and a company&#8217;s ability to satisfy its long-term and other obligations.<\/p>\n<h3>Liquidity Ratios<\/h3>\n<p>$$ \\begin{array}{c|c|c}<br \/>\\textbf{Ratio Name} &amp; \\textbf{Calculation} &amp; \\textbf{Indication} \\\\ \\hline<br \/>\\text{Current Ratio} &amp; \\frac{\\text{Current assets}}{\\text{Current liabilities}} &amp; {\\text{A company\u2019s} \\\\ \\text{ability to meet its} \\\\ \\text{short-term obligations} } \\\\ \\hline<br \/>{\\text{Quick Ratio} \\\\ \\text{(Acid Test)} } &amp; \\frac{ \\text{Cash}+\\text{Marketable securities}+\\text{Receivables}}{\\text{Current liabilities}} &amp; {\\text{It satisfies the} \\\\ \\text{same purpose as} \\\\ \\text{the current ratio} \\\\ \\text{but is considered a} \\\\ \\text{stricter measure as} \\\\ \\text{inventory is} \\\\ \\text{excluded.} } \\\\ \\hline<br \/>\\text{Cash Ratio} &amp; \\frac{\\text{Cash}+\\text{Marketable securities}}{\\text{Current liabilities}} &amp; {\\text{Test a company\u2019s} \\\\ \\text{ability to meet its} \\\\ \\text{short-term} \\\\ \\text{obligations using} \\\\ \\text{highly liquid} \\\\ \\text{assets.}}<br \/>\\end{array} $$<\/p>\n<h3>Solvency Ratios<\/h3>\n<p>$$ \\begin{array}{l|c|c}<br \/>\\textbf{Ratio Name} &amp; \\textbf{Calculation} &amp; \\textbf{Indication} \\\\ \\hline<br \/>\\text{Long term debt-to-equity} &amp; \\frac{\\text{Total long term debt}}{\\text{Total debt}} &amp; {\\text{Financial leverage} \\\\ \\text{and financial risk} } \\\\ \\hline<br \/>\\text{Debt-to-equity} &amp; \\frac{\\text{Total debt}}{\\text{Total equity}} &amp; {\\text{Financial leverage} \\\\ \\text{and financial risk} } \\\\ \\hline<br \/>\\text{Total debt} &amp; \\frac{\\text{Total debt}}{\\text{Total assets}} &amp; {\\text{Financial leverage} \\\\ \\text{and financial risk}} \\\\ \\hline<br \/>\\text{Financial leverage} &amp; \\frac{\\text{Total assets}}{\\text{Total equity}} &amp; {\\text{Financial leverage} \\\\ \\text{and financial risk}} \\end{array} $$<\/p>\n<h3>Issues with Ratio Analysis<\/h3>\n<p>The effectiveness of cross-sectional financial ratio analysis can be constrained by variations in accounting practices. Furthermore, comparability can be hindered by the lack of uniformity in a company&#8217;s operational activities. To circumvent this limitation, diversified companies active in multiple industries can employ industry-specific ratios for distinct business segments can enhance comparison.<\/p>\n<p>Conducting ratio analysis involves considerable judgment. One critical aspect of this judgment is recognizing the limitations of any given ratio. Additionally, it requires judgment to determine whether a ratio indicates a long-term trend or merely a short-term situation. For instance, a drawback of the current ratio is its susceptibility to changes in end-of-period financing and operational decisions that can impact the amounts of current assets and liabilities<\/p>\n<blockquote>\n<h2>Question 1<\/h2>\n<p>The following balance sheet information is given for company XYZ.<\/p>\n<p>$$ \\textbf{Company XYZ Balance Sheet} \\\\<br \/>\\begin{array}{l|r}<br \/>\\text{Assets} &amp; {\\text{Dec } 31, 2016(\\$)} \\\\ \\hline<br \/>\\text{Current Assets} &amp; \\\\ \\hline<br \/>\\text{Cash and cash equivalents} &amp; 100, 000 \\\\ \\hline<br \/>\\text{Short-term marketable securities} &amp; 1,234, 678 \\\\ \\hline<br \/>\\text{Accounts receivable} &amp; 52, 000 \\\\ \\hline<br \/>\\text{Inventory} &amp; 1,170, 356 \\\\ \\hline<br \/>\\text{Total current assets} &amp; 2,557, 034 \\\\ \\hline<br \/>\\text{Property, plant, and equipment (PPE)} &amp; 6,834, 190 \\\\ \\hline<br \/>\\text{Intangible assets} &amp; 3,370, 041 \\\\ \\hline<br \/>\\text{Total assets} &amp; 12,761, 265 \\\\ \\hline<br \/>\\text{Liabilities and shareholders&#8217; equity} &amp; \\\\ \\hline<br \/>\\text{Current Liabilities} &amp; \\\\ \\hline<br \/>\\text{Accounts payable} &amp; 3,825, 396 \\\\ \\hline<br \/>\\text{Total current liabilities} &amp; 3,825, 396 \\\\ \\hline<br \/>\\text{Bonds payable} &amp; 3,771, 894 \\\\ \\hline<br \/>\\text{Total liabilities} &amp; 7,597, 290 \\\\ \\hline<br \/>\\text{Total shareholders&#8217; equity} &amp; 5,163, 975 \\\\ \\hline<br \/>\\text{Total liabilities and shareholders&#8217; equity} &amp; 12,761, 265<br \/>\\end{array} $$<\/p>\n<p>The current ratio for company XYZ is <em>closest to<\/em>:<\/p>\n<ol type=\"A\">\n<li>0.34.<\/li>\n<li>0.67.<\/li>\n<li>1.20.<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is<strong> B<\/strong>.<\/p>\n<p>$$<br \/>\\text{Current ratio}=\\frac{\\text{Current assets}}{\\text{Current liabilities}}=\\frac{2,557,034}{3,825,396}=0.67 $$<\/p>\n<h2>Question 2<\/h2>\n<p>To convert a regular balance sheet into a common-size balance sheet, each line item is stated as a percentage of:<\/p>\n<ol type=\"A\">\n<li>Total assets.<\/li>\n<li>Total equity.<\/li>\n<li>Total liabilities.<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is<strong> A.<\/strong><\/p>\n<p>Making a common-size balance sheet requires stating each line item as a percentage of total asset.<\/p>\n<\/blockquote>\n<div style=\"text-align: center; margin: 40px 0;\"><a style=\"background: #1a73e8; color: #ffffff; padding: 14px 26px; border-radius: 999px; text-decoration: none; font-weight: bold; font-size: 16px; display: inline-block;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener\"> Start Free Trial \u2192 <\/a><\/p>\n<p style=\"margin-top: 10px; font-size: 14px; color: #555;\">Access CFA Level I practice questions, video lessons, and study notes covering common-size balance sheets, liquidity ratios, solvency analysis, and financial statement interpretation.<\/p>\n<\/div>","protected":false},"excerpt":{"rendered":"<p>Examining a company&#8217;s balance sheet can reveal information about its liquidity and solvency at the time the balance sheet is prepared, as well as the economic resources under the company&#8217;s control. Recall that liquidity is defined as the company\u2019s ability&#8230;<\/p>\n","protected":false},"author":7,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[5],"tags":[],"class_list":["post-46916","post","type-post","status-publish","format-standard","hentry","category-financial-reporting-and-analysis","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Common Size Balance Sheet &amp; Ratios Explained | AnalystPrep<\/title>\n<meta name=\"description\" content=\"What is a common size balance sheet? Learn how to analyze balance sheet ratios using time-series and cross-sectional methods. 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