1.1 Common-size Financial Statements

Question 1

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.

Answer 1

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.

Question 2

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.

Answer 2

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.

Question 3

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%

Answer 3

B. (20%)

Question 4

Purpose of common-size financial statements

Answer 4

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