Commonsize Analysis

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Common-size Analysis

• Chapter 5
• UWYO COB ACCT 2000

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Learning Objectives

• Evaluate common-size financial statements
• Use common-size analysis to forecast earnings

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Common-size AnalysisIncome Statement

• Vertical analysis
• Compare among companies of different sizes
  (cross-sectional)
• Does not control for differences in accounting
  methods
• Horizontal analysis
• Compare a company to itself (time-series)
• P5-1, P5-2, P5-3

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Vertical analysis example
P5-11 P5-13
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Vertical analysis Cautions

• Tax rate (P5-5)
• Outsourcing (P5-6)
• Subsidiary (P5-8)

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Horizontal analysis example
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Horizontal analysis example
P5-7 P5-12
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Horizontal analysis Operating Leverage

• Indicates how operating income will change as
  sales change

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Operating Leverage Example

• Revenues 1,250
• Variable costs 950
• Operating income 200
• Operating leverage 1.5
• A 10 increase in sales will result in a 15
  increase in operating income
• However, a 10 decrease in sales will result in a
  15 decrease in operating income

P5-4, P5-9, P5-10 P5-15
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Common-size AnalysisBalance Sheet

• Vertical analysis
• Horizontal analysis

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Vertical analysis example
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Vertical analysis example
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Horizontal analysis example
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Horizontal analysis example
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Cross-sectional Comparisons

• Compare firm with peers
• Compare firm with industry averages
• Adjust for differences in accounting methods
  before comparison

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Cross-section Income Statement
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Cross-section Balance Sheet
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Interim Reports

• Generally unaudited but more timely
• quarterly
• semi-annually
• Revise earnings forecast based on interim reports
• Need to consider seasonality

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Motorola Interim Analysis
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Forecasting Earnings

• Step 1 predict earnings structure
• Based on vertical common size I/S
• Step 2 predict sales
• Based on horizontal common size I/S
• Step 3 predict earnings
• Based on predicted earnings structure (step 1)
  and predicted sales (step 2)

P5-14
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Summary

• Common-size financial statements
• Vertical (cross-sectional analysis)
• Horizontal (time-series analysis)
• Three steps to forecast earnings using
  common-size analysis

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Case 5-1

• Vertical common-size analysis
• Horizontal common-size analysis
• Implications on forecasting earnings

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Problems Cases

• Vertical common-size analysis
• Information P5-1 (A), P5-2 (C)
• Attention tax P5-5 (D), outsourcing P5-6 (D),
  subsidiary P5-8 (A)
• Analyze Case 5-1 (B. not a positive signal) ,
  P5-11 (Selling Administrative) , P5-13 (less
  efficient)
• Horizontal common-size analysis
• Information P5-3 (C)
• Analyze P5-7 (D), P5-12 (B. SGA C. OL2 D.
  NI504)
• Operating leverage P5-4 (B), P5-9, P5-10 (OL and
  FL are distinct), P5-15 (OL1.5, sales1,250(1-
  100/1.5)417 )
• Forecast earnings based on common-size analysis
• P5-14 (A. net profit612 B. OL5)