1. Chapter 5 Robinson, Munter, Grant
Common-size Analysis
Chapter 5
Robinson, Munter, Grant

2. Learning Objectives
Prepare and evaluate common-size financial statements in cross-sectional and time-series
Explain operating leverage
Evaluate common-size interim data
Use this analysis to forecast earnings
Grant, Munter & Robinson
Chapter 5

3. Common-size Analysis
Allows comparisons of companies of different sizes
Based on assets or revenues
Understand the nature of costs
Variable: move in proportion to sales
Fixed: unchanged within a relevant range of activity
Grant, Munter & Robinson
Chapter 5

4. Common-size Analysis Income Statement
Vertical analysis – income statement items are expressed as a percentage of sales
Sales = 100%
Each line item = Item/Sales
Horizontal analysis with a base year
Each line item of base year = 100%
Growth/decline is relative to base year
Focus on changes over time
Use to forecast earnings
Grant, Munter & Robinson
Chapter 5

5. Nokia Income Statements
Grant, Munter & Robinson
Chapter 5

6. Nokia’s Vertical Common-size Income Statements
Grant, Munter & Robinson
Chapter 5

7. Nokia Common-size Income Statements (1999 is base year)
Grant, Munter & Robinson
Chapter 5

8. Nokia Common-size Income Statements (Change from base, 1999 is base year)
Grant, Munter & Robinson
Chapter 5

9. Grant, Munter & Robinson
Chapter 5

10. Grant, Munter & Robinson
Chapter 5

11. Grant, Munter & Robinson
Chapter 5

12. Grant, Munter & Robinson
Chapter 5

13. Operating Leverage
Positive when percentage increases in net income exceed percentage increases sales
A scalar indicating how net income will change as revenues change
Grant, Munter & Robinson
Chapter 5

14. Operating Leverage Example
Revenues = $1,250
Variable costs = $950 (Contribution margin = $300)
Operating income = $200
Operating leverage = 1.5 ($300/$200)
A 10% increase in sales will result in a 15% increase in operating income
Grant, Munter & Robinson
Chapter 5

15. Operating Leverage
Approximated by:
Grant, Munter & Robinson
Chapter 5

16. Common-size Analysis Balance Sheet
Vertical analysis
Set total assets = 100%
Divided each balance sheet time by total assets
Horizontal analysis
Set base year = 100%
Determine relative change (growth/decline) from base year amount
Grant, Munter & Robinson
Chapter 5

17. Grant, Munter & Robinson
Chapter 5

18. Grant, Munter & Robinson
Chapter 5

19. Grant, Munter & Robinson
Chapter 5

20. Grant, Munter & Robinson
Chapter 5

21. Grant, Munter & Robinson
Chapter 5

22. Grant, Munter & Robinson
Chapter 5

23. Grant, Munter & Robinson
Chapter 5

24. Grant, Munter & Robinson
Chapter 5

25. Cross-sectional Comparisons
Compare firm to peers
Compare firm to industry averages
In a single time period
Differences in accounting methods and business models make this analysis difficult
Grant, Munter & Robinson
Chapter 5

26. Cross-section: 2001 Nokia Motorola Sales 100% Operating profit 11%
-23%
Pretax income
-18%
Net profit 7%
-13%
Grant, Munter & Robinson
Chapter 5

27. Cross-section Balance Sheet
2001
Nokia
Motorola
Industry
Current Assets
69%
51%
65%
Fixed Assets, net
11%
27%
23%
Current Liabilities
43%
29%
33%
Long-term Debt 1%
25%
12%
Stockholders’ Equity
54%
41%
Grant, Munter & Robinson
Chapter 5

28. Interim Reports Generally unaudited
More timely; prepared quarterly or semi-annually
Detect trends and seasonality
Compare results of current period to those presented in annual reports
Data can be used to forecast earnings
Grant, Munter & Robinson
Chapter 5

29. Motorola Interim Analysis
First Quarter
2002
2001
Net revenue
$6,021
100%
$7,683
Gross margin
1,773
29%
1,566
21%
Operating income
(362)
-6%
(1,106)
-14%
Net income
(449)
-7%
(533)
Grant, Munter & Robinson
Chapter 5

30. Summary Common-size income statement Operating leverage
Common-size balance sheet
Interim reports
Grant, Munter & Robinson
Chapter 5