Common-size analysis

Question

Common-size analysis is a simple way to make financial statements of different firms comparable. What are
possible shortcomings of comparing two different firms using common-size analysis?

Sample Answer from Our Tutor

Restating income statement line items as a percentage of sales and balance sheets as a percentage of total
assets enables the analyst to compare different firms regardless of size. However, at least three possible
limitations could impact the benefits of common-size analysis.

First, firms often categorize or group expenses in different line items, which can make it difficult to force dissimilar financial statements into a standardized
format.

Second, firms do not always share the same fiscal year-ends, so balance sheets and income statements
may be misaligned in time, which could matter in rapidly changing economic environments. Third, firms
may use or be subject to different accounting practices that may affect the comparability of common-size
financial statements.