Common-Size & Trend Analysis: How to Compare "Apples to Oranges"
Imagine trying to compare a small birthday cupcake to a massive wedding cake.
- The wedding cake has 10kg of sugar.
- The cupcake has 10g of sugar.
Does that mean the wedding cake is "sweeter"? Not necessarily. You need to know the percentage of sugar in each cake to compare their taste fairly.
In finance, this is called Common-Size Analysis . It allows you to compare a small startup with a giant multinational corporation by converting all their confusing numbers into simple percentages.
The Golden Rule: Absolute numbers hide the truth. Percentages reveal the truth.
1. Common-Size Analysis (Vertical Analysis)
This method takes a financial statement and converts every item into a percentage of a "base figure".
A. In the Income Statement
Base Figure = Total Revenue (Sales).
Every expense is expressed as a % of Revenue.
| Item | Company A (₹) | Common Size (%) |
|---|---|---|
| Revenue | ₹1,00,000 | 100% |
| COGS (Cost) | ₹60,000 | 60% |
| Gross Profit | ₹40,000 | 40% |
Why is this useful?
If Company B has ₹10,00,000 revenue but its Gross Profit % is only 30%, you know Company A is more efficient at making products, even though it is smaller.
B. In the Balance Sheet
Base Figure = Total Assets.
Every asset and liability is expressed as a % of Total Assets.
- "Cash is 10% of Total Assets." (Good liquidity).
- "Debt is 80% of Total Assets." (High risk!).
2. Trend Analysis (Horizontal Analysis)
While Common-Size looks at one year vertically, Trend Analysis looks across time horizontally. It’s like watching a child grow year by year.
It helps you spot patterns: "Is the company getting better or worse?"
The Formula
% Change = (Current Year - Base Year) / Base Year × 100
Example: The Warning Sign
- Year 1: Sales = ₹100, Profit = ₹10.
- Year 2: Sales = ₹150 (Up 50%), Profit = ₹12 (Up 20%).
Analysis: Wait a minute! Sales grew by 50%, but Profit only grew by 20%. Why? Costs must be rising faster than sales. This is a red flag that Trend Analysis reveals instantly.
3. How to Use Both Together
The best analysts use both methods like a detective.
- Step 1 (Trend): Look at the last 5 years. Is Revenue growing? Is Debt growing faster than Assets?
- Step 2 (Common-Size): Compare margins. Did the Net Profit Margin drop from 15% to 10%? If yes, why? Did marketing costs go up?
- Step 3 (Peer Comparison): Compare your company's percentages with its competitor. If your company spends 20% on marketing while the competitor spends only 10%, ask why.
Real World Case: Retail Sector
Walmart vs. Luxury Brand
Walmart has a very low Net Profit Margin (around 2-3%) because it sells cheap goods in high volume. A luxury brand like Louis Vuitton has a high margin (20%+) because it sells expensive items.
Common-Size analysis helps you understand the
business model
instantly.
4. Summary
- Common-Size (Vertical): Helps you compare companies of different sizes by using percentages.
- Trend (Horizontal): Helps you see the direction (growth or decline) over time.
- Together: They reveal the true story behind the raw numbers.
Frequently Asked Questions
What is Common-Size Analysis?
Common-Size Analysis (also called Vertical Analysis) converts every number in a financial statement into a percentage. In the Income Statement, everything is shown as a percentage of Revenue. This allows you to compare companies of completely different sizes.
What is Trend Analysis?
Trend Analysis (Horizontal Analysis) compares financial data over a period of time (years or quarters) to identify patterns. It helps answer questions like 'Are profits growing faster than sales?' or 'Is debt increasing year after year?'.
Why are percentages better than absolute numbers?
Absolute numbers can be misleading. A ₹100 Crore profit sounds huge, but if the revenue was ₹10,000 Crores, the margin is only 1%. Percentages reveal efficiency and margins, which absolute numbers often hide.