Question

Select the correct option(s):

a. Common-size balance sheets allow for comparison of firms with different levels of total assets by introducing a common denominator.
b. The common-size balance sheet reveals the composition of assets within major categories.
c. Each item on a common-size balance sheet is expressed as a percentage of sales.
d. The common-size balance sheet reveals the capital and the debt structure of the firm.

Answer 1

Answer: a. The common-size balance sheet allow for comparison of firms with different levels of total assets by introducing a common denominator.

Explanation: The common-size balance sheets are those balance sheets in which the structure of each part of the assets, liabilities and equity major categories are detailed, each one with their absolute value (the amount) and their relative value (percentage of the total).

For example, assets are 5 million dollars, capital 3 million and liabilities 2 million. Cash is 1 million. So in the common-size balance sheet you will see Cash (or liquidity) for 1 million dollars and 20%.

This way you can compare two or more firms with different ammount of assets (one with 8 million with one of just 1 million, for example) as indicating which is the percentage of liquidity for each one, or their percetage of liabilities, etc. The relative value, which is made in the common-size balance sheets makes this comparisson possible.