One example of the use of common size ratios is to calculate what percentage of total assets each asset on the balance sheet equals. Here is a simple example:
Common size ratio
Cash $100 20% (=$100 ÷ $500)
Accounts receivable $250 50%
Fixed Assets $150 30%
Total assets $500
Now compare your common size ratios with other businesses (if possible) and other accounting periods. If for example, the previous year for your business showed a common size ratio of 10% for accounts receivable, this year’s figure of 50% is a concern and something you should be looking at, without delay, in order to understand the reasons. Accounts receivable in themselves are not a bad thing, but an increased percentage can indicate poor collection practices or declining customer quality. It is the trends and comparisons that are usually most important in understanding how your business is doing right now, and its likely future prospects.
You can also look at common size ratios for your income statement and liabilities.
Please talk to us if you have any questions.