What is Common Size Income Statement Analysis?
The term “common size income statement” refers to the presentation of all the line items in an income statement in a separate column in the form of relative percentages of total sales primarily. It is not another type of income statement, but it is just one type of technique used by financial managers to analyze the income statement of a company.
- In financial statement analysis, it is used to compare companies that operate in the same or different industries or to compare the performance of the same company over different time periods.
- Further, it helps a financial analyst to establish a relationship between each of the accounts in the income statement and the total sales and eventually helps in ascertaining how each of the accounts affects the total profitability.
- From the perspective of an investor, it gives a clear picture of the various expense accounts, which are subtracted from the total sales to generate the net income.
Examples of Common Size Income Statement Format
Let us take the common size income statement example of Apple Inc. to understand the concept of the common size income statement and see the trend in the financials of the last three years.
All Amount in Millions
For instance, it can be seen that the gross profit margin and operating income margin has been quite stable over the last three financial years. However, the net income has witnessed slight improvement during the same period. An analyst can further deep dive to determine the reason behind the same to make a more meaningful insight.
Here you can download the detailed excel template
Common Size Format of Colgate’s Income Statement
- Gross Profit Margin of Colgate has always remained above 50% in all these years.
- SG&A expense has decreased from 36.1% in 2007 to 34.1 in 2005.
- Effective Tax rates increased to 44% in 2015 as compared to an average of 32-33% in earlier years.
- Operating income has dropped significantly in 2015.
- Net income decreased substantially to less than 10%.
Advantages of Common Size Income Statement Analysis
- A helps a financial user to understand the income statement more clearly in terms of ratio or percentage of each individual item in the income statement as a percentage of total sales of the company.
- It helps an analyst to ascertain the trend with respect to the percentage share of each item on the income statement and their impact on the net income of the company.
- A financial analyst can use a common size income statement to compare the financial performances of different entities at a glance since each item is expressed in terms of percentage of total sales.
Disadvantages of Common Size Income Statement Analysis
- Many financial experts see the common size income statement as useless because there isn’t any approved standard proportion of each item to the total sales.
- If the year after year preparation of the income statement of a particular company is not consistent basis, then perform any comparative study of common size statement income statement may end up to be misleading.
Limitations of Common Size Income Statement Analysis
- It does not help in the decision-making process as there is no approved standard proportion with regard to the component of the income statement as a percentage of total sales.
- In case there is a lack of consistency in the preparation of the financial statements owing to changes in accounting principle, concepts, conventions, then a common size income statement becomes quite irrelevant.
- It is impossible to ignore the effects of window dressing in financial statements. However, a common size income statement fails to figure out the same to provide the actual effect of each expense account on the net income.
- It also fails to distinguish the qualitative elements while evaluating a company’s performance.
- It does not convey proper records during times of seasonal fluctuations in various components of the income statement. As such, it fails to provide the actual information to the financial users of the statement.
In conclusion, it can be said that the common size income statement facilitates easy comparison. It makes analysis much easier such that the analyst can see what is actually driving the profit of a company, and then compare that performance to its peers. It allows an analyst to look at how the performance has changed over the period of time. From an investor’s perspective, a common size income statement helps in spotting patterns in the performance of the company that a raw income statement may not uncover.
This has been a guide to Common Size Income Statement. Here we what is Common Size Income Statement analysis, its format with excel examples, advantages, and disadvantages and limitations. You may learn more about from the following articles –