One of the tools mentioned earlier, common size analysis is a highly useful method in analyzing and comparing data. This type of analysis ‘converts selected items in financial statements to percentages of size related measures’ (Huang and Liu 2006, p.1). When we utilize this technique to analyze balance sheets, items of balance sheets are expressed in proportion to total assets. This is the same with income statements where items are expressed in proportion to net sales or net income.

There are two basic types of common size analysis – horizontal analysis and vertical analysis. In horizontal analysis, comparisons are made for specific items across years. For example, if Cost of Goods Sold is £ 100,000 in Year 1 and £ 150,000 in Year 2, the Cost of Goods Sold has increased by 50 %. In vertical analysis, the items in a profit and loss statement are divided by Sales and items in the balance sheet are divided by the Total Assets and hence shown as a proportion to those items. For example, if Total Assets are £ 1 Million and Inventory, Accounts Receivable and Current Liabilities are £ 100,000, £ 40,000 and £ 200,000 respectively, then Inventory are 10 percent of Total Assets, Accounts Receivable are 4 percent of Total Assets and Current Liabilities are 20 percent of Total Assets (Brigham and Ehrhardt 2001). The main advantage of Common Size Analysis is that it affords companies the luxuries of comparing data over a period of time and also comparisons can be made among different companies. Also, companies of different sizes can be compared as the data is expressed as a percentage (Bernstein and Wild 1999).