N Sivasankaran

All of us start the wealth creation process by setting our goal in monetary terms. For instance, Diptesh Ravi, a middle-level management professional aims to generate a wealth of R 25 lakh at the end of the fifth year. After three years of planned wealth generation horizon, he gets the report card on his progress, which reads that he has accumulated R10 lakh, instead of the planned amount of R15 lakh. At this juncture, he would like to know what went wrong. That?s where Common-Size Statement Analysis (CSSA) emerges as a guide.

Common-size statements: They are used to assess the intra- and inter-company performance in terms of sources of revenue, composition of expenses, composition of assets and sources of finance. In other words, a company can compare its 2012 numbers with that of the last two years, say 2011 and 2010, on revenue, expenses, assets, liabilities and owner’s equity. The objective is to find out positive or negative trends in performance indicators.

On the other hand, a company can also compare its performance with that of the competitors using common-size statements. The commonality in these two types of analysis ? intra- and inter-company ? is that all components of the statement are presented as a percent of the key variable. The key variable in a common-size income statement is net sales and it is total assets in a common size balance sheet.

Personal income statement: Ravi needs to start the analysis by preparing his personal income statement for the last three years. The income statement can be presented in a vertical format. Assuming that the accumulated surplus of Ravi in the three years is R10.76 lakh, the accumulated wealth comes around R10 lakh. The difference is due to the depreciation of assets, which is a non-cash expense head that appears in his income statement. All items, except depreciation, are cash revenue or expenses. In other words, an individual?s income statement is not prepared on purely accrual or cash basis; rather, it is prepared mostly on cash basis, except for the depreciation of expenses.

Common-size income statement: We can prepare a common-size income statement for Ravi to trace the variance in the actual performance from that of the planned/budgeted performance.

Inferences: From the common-size income statement of Ravi, we can see that the contribution of operating revenue in the total revenue is declining year after year, while the share of other income in total revenue is in the increasing trend.

Total expenses as a percent of total revenue comes down from 76.39% to 74.67% in the second year, but shoots up to 86% in the third year. This trend gets reflected in the surplus generated by Diptesh Ravi, i.e., the surplus slightly goes up in the second year, while it comes down drastically in the third year.

The declining trend in surplus compels us to look at the trend of all expense heads. The expense heads that emerge as the major contributors for the declining surplus are festival and entertainment, income tax, clothing, utilities and grocerry.

Interest expense comes down over the years, while other expense heads exhibit a fluctuating trend. Nevertheless, the picture is clear that his expenses went slightly out of desired zone in the third year. These insights will enable us to take corrective measures. For instance, the income-tax expense can be reduced by making investment in tax-saving avenues to the extent of the maximum tax deduction limit.

The author teaches accounting and finance courses at IIM Ranchi