Which of the following would an analyst most likely be able to determine from a common-size analysis of a company’s balance sheet over several periods?
A) an increase or decrease in sales
B) an increase or decrease in financial leverage
C) a more efficient or less efficient use of assets
This question is in the FRA Curriculum Book at the end of the chapter (26). What is the logic process behind this answer? The book’s answer wasn’t detailed. FInancial Leverage is Asset/Equity, yet vertical common size analysis for the b/s means % of Assets.
How does one see the change in Financial Leverage via common size (vertical or horizontal; the question is quite ambiguous)?
Increase or decrease in Sales -> Sales is an Income statement item. On common size analysis - you divide sth on the income statement by itself. So it would provide an answer of 1… no value here.
Every item on income statement is divided by Sales to common size it. (So you would not know what happened).
Financial leverage -> is Debt/Equity or debt/assets - both of which are on the balance sheet. and that you would get by dividing by Total Assets. This will tell you if sth increased or decreased properly.
More or less efficient use of assets - again going by the fact that assets would be divided by itself - no value here.