Explain how to create a common size income statement and a common size

Explain how to create a common size income statement and a common size balance sheet. Provide at least three reasons why analysts find the creation of common size statements to be a useful practice.

What will be an ideal response?

ANSWER

The student should understand that each item on the income statement is divided by the total revenues (the author suggests net sales). Thus, each income statement item is rewritten as a percentage of sales. For the balance sheet the denominator is total assets for the calculation of common size values.
There are many advantages to viewing financial statements in common size form. We can anticipate that students will identify the ease of comparing firms of significantly different sizes. Another advantage is the ease of benchmarking against industry averages, industry leaders, or close competitors. Further, the firm can benchmark against itself over time by comparing values today against previous time periods.