STANDARDIZED FINANCIAL STATEMENTS
The next thing we might want to do with Prufrock’s financial statements is to
compare them to those of other, similar, companies. We would immediately have a
problem, however. It’s almost impossible to directly compare the financial statements
for two companies because of differences in size.
For example, Ford and GM are obviously serious rivals in the auto market, but GM is
much larger (in terms of assets), so it is difficult to compare them directly. For that matter,
it’s difficult to even compare financial statements from different points in time for the
same company if the company’s size has changed. The size problem is compounded if
we try to compare GM and, say, Toyota. If Toyota’s financial statements are denominated
in yen, then we have a size and a currency difference.
To start making comparisons, one obvious thing we might try to do is to somehow
standardize the financial statements. One very common and useful way of doing this is
to work with percentages instead of total dollars. In this section, we describe two
different ways of standardizing financial statements along these lines.
Common-size statements
To get started, a useful way of standardizing financial statements is to express each
item on the balance sheet as a percentage of assets and to express each item on the
income statement as a percentage of sales. The resulting financial statements are called
common-size statements.
Common size balance sheet
One way, though not the only way, to construct a common-size balance sheet is to
express each item as a percentage of total assets. Prufrock’s 2001 and 2002 common-
size balance sheets are shown in Table 3.5. Notice that some of the totals don’t check
exactly because of rounding errors. Also notice that the total change has to be zero
because the beginning and ending numbers must add up to 100 percent.
In this form, financial statements are relatively easy to read and compare. For
example, just looking at the two balance sheets for Prufrock, we see that current assets
were 19.7 percent of total assets in 2002, up from 19.1 percent in 2001. Current liabilities
declined from 16.0 percent to 15.1 percent of total liabilities and equity over that same
time. Similarly, total equity rose from 68.1 percent of total liabilities and equity to 72.2
percent. Overall, Prufrock’s liquidity, as measured by current assets compared to current
liabilities, increased over the year. Simultaneously, Prufrock’s indebtedness diminished
as a percentage of total assets. We might be tempted to conclude that the balance sheet
has grown “stronger.” We will say more about this later.
Common-size statements of cash flow
Although we have not presented it here, it is also possible and useful to prepare a
common-size statement of cash flows. Unfortunately, with the current statement of cash
flows, there is no obvious denominator such as total assets or total sales.
