The common size ratio is a great way to see how big each accounting item in your business is compared to the others. For example, the common size ratio can tell you if a particular line item on your balance sheet or income statement is very big or very small when measured against the other items. In the most basic sense, when you are looking at a line item, say rent expense, the common size ratio shows you what percentage of expenses the rent expense is. If you are looking at online sales, the common size ratio shows you what percentage of total sales are made online.
Using the common size ratio in practice is simple. You can easily calculate it on your financial statements by doing the following:
- Look at each item on the financial statement you are analyzing.
- Take the value of that item and divide it by the total to get a percentage.
This is the common size ratio. You can compare each item versus each other items, or look at trends in a single line item to see if things are improving or degrading over time.
As a direct example, assume your small business makes sales in three ways: through phone calls, in-person visits to prospects, and online sales. Assume the phone call sales are $100,000, the in-person sales are $50,000, and the online sales are $200,000. This means that your total sales are $350,000. To find the common size ratio of each sales line item, take the amount and divide it by $350,000. This means that phone sales are $100,000 / $350,000, or 28.6%. In-person sales are $50,000 / $350,000, or 14.3%, and online sales are $200,000 / $350,000, or 57.1%.
The common size ratio can help you make strategic business decisions over time by tracking and analyzing the growing or decreasing values of each item in your business compared to the whole. While simple in nature, the idea can help you focus on strengths and weaknesses in your business.