4.4 Approaches to Financial Statement Analysis

It is similar to comparative financial statements except that a base year is chosen and all values for that year are expressed as 100%. Subsequent years are then expressed in terms of percentages calculated on the base year.

It is often useful to show individual items as a proportion of the total group. In a common size Statement of Financial Position, each item is expressed as a percentage of total assets. A common size analysis enables us to monitor changes and trends in margins and costs.

A ratio expresses the relationship between one quantity and another. The ratios of 80 to 100 are expressed as 0.8:1 or 80%. While the computation of ratios is simple, the interpretation tends to be more complex. Since ratios are used by analysts to make projections about the future, the analyst should also understand the factors that will affect such ratios in the future.