What Is Common Size Income Statement?
Common Size Income Statement presents every line item available in the company’s income statement in the form of the relative percentage of sales. It helps in analyzing the items that are driving the company’s profits.
In it the line items in an income statement are presented 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 technique used by financial managers to analyze a company’s income statement. From an investor’s perspective, it gives a clear picture of the various expense accounts, which are subtracted from the total sales to generate the net income.
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- The common size income statement presents every line item in a company’s income statement as a percentage of sales.
- Financial managers use this method to validate a company’s income statement. Consistency in financial reporting is essential since changes in accounting principles, concepts, and conventions can affect the accuracy of the results.
- The common size income statement is a valuable tool for analysts to understand how a company’s performance has changed over time.
- It also allows investors to identify company performance patterns beyond what is presented in the basic income statement.
Common Size Income Statement Explained
The common size income statement, is the profit and loss statement of the company where each line item is shown as a percentage of the total sales. This is not a separate income statement, but just a process to display the line items that will help analysts understand and interpret the statement for various purpose.
A sample common size income statement helps in comparison of the proportion of various income and expenses within the profit and loss statement for the purpose of financial decision making. It gives valuable insight into the financial health and structure of the business relative to the sales made so that they can take decisions related to expense management, production techniques etc. It facilitates trend analysis and comparison of the financial statement over a period of time.
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. From an investor’s perspective, a common size income statement helps spot patterns in the company’s performance that a basic income statement may not uncover.
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 establish a relationship between each of the accounts in the income statement and the total sales and eventually helps ascertain how each of the accounts affects the total profitability.
How To Calculate?
Now let us understand how to calculate and prepare common size income statement the statement line items so that it represents each items a s a percentage of the sales made.
- The first step is to take the income statement of the business which is in a standard format and which clearly shows the revenues and expenses on the business made for that period. The time period may be a quarter or annual.
- The next step is to calculate the value of the line items in the statement to express them in terms of sales percentage. This will be done by dividing the item by the total revenue amount and multiplying the obtained result by 100, to express it as a percentage.
- Then, in order to display the items clearly for proper understanding of the sample common size income statement, each common size percentage value should be written along side the real amount for facilitating comparison. For this purpose, it is better to create a separate column which will have the respective percenatges.
- Thus the details for analysis is ready. After all the items have bebn expressed in percentage terms relative to the revenue earned, the analysts and investors can find the trends and areas of strength and rooms for improvement. The statement can be compared with similar ones for the previous years for financial decision making.
The steps mentioned above are used to prepare the common size income statement of any business. However, it may bcome a complex process, depending on the size and nature of business operations.
How To Interpret?
It is important to understand how to interpret the results and percentage values obtained so that they can be used for the correct objective.
- The analyst should first prepare common size income statement and analyse the items by identifying them, like the revenue, gross profit, operating expenses, net income, etc. They are the most important ones. Here the total revenue is assumed to be100%, based on which the percentages of sales segregations is calculated. The analyst should notice the trends in such values. If the percentage has improved, it shows a betterment in the income generation stream.
- Items like gross profit margin and net profit margin , which are the gross and net profits respectively, calculated as a percentage of the revenue, should be analysed to understand if there is a rise or fall. A rise would definitely indicate improvement in business operations and is a clear signal of growth.
- Interest expenses and tax calculated as percentage of revenue will show the rise or fall in debt repayment and tax payable, whose rise is actually a negative sign, indication financial burden.
- The analysts should also look for increase in any non-recurring items, and why they have occurred. Any deviation from the normal should be taken into account. Deviations can be compared to historical data or industry benchmark data to identify financial challenges and take decisions accordingly.
Thus, the above common size income statement interpretation helps investors, analysts and management to identify challenges, opportunities and growth of the company.
Let us try to undestand the concept of common size income statement interpretation with the help of some suitable examples.
Let us take the example of Apple Inc. to understand the concept and see the trend in the financials of the last three years.
All Amount in Millions
|Cost of Revenue||$1,63,756||$1,41,048||$1,31,376||61.70%||61.50%||60.90%|
|Research & Development||$14,236||$11,581||$10,045||5.40%||5.10%||4.70%|
|Sales, General & Admin||$16,705||$15,261||$14,194||6.30%||6.70%||6.60%|
|Add Income and Expense Items||$2,005||$2,745||$1,348||0.80%||1.20%||0.60%|
|Earnings Before Interest and Tax||$72,903||$64,089||$61,372||27.40%||28.00%||28.50%|
|Earnings Before Tax||$72,903||$64,089||$61,372||27.40%||28.00%||28.50%|
For instance, we can see that the gross profit margin and operating income margin have been quite stable over the last three financial years. However, the net income has witnessed a 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.
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- The Gross Profit MarginGross Profit MarginGross Profit Margin is the ratio that calculates the profitability of the company after deducting the direct cost of goods sold from the revenue and is expressed as a percentage of sales. It doesn’t include any other expenses into account except the cost of goods sold. of Colgate has always remained above 50% in all these years.
- SG&A expense had decreased from 36.1% in 2007 to 34.1 in 2005.
- Effective Tax ratesEffective Tax RatesEffective tax rate determines the average taxation rate for a corporation or an individual. For both, there is a similar formula only with variation in considering variables. The effective tax rate formula for corporation = Total tax expense / EBT increased to 44% in 2015 as compared to an average of 32-33% in earlier years.
- Operating income dropped significantly in 2015.
- Net income decreased substantially to less than 10%.
Common Size Income Statement In Video
Let us identify the advantages of the same as given in the points below.
- A helps a financial user to understand the income statementUnderstand The Income StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements. more clearly in terms of the ratio or percentage of each item in the income statement as a percentage of the company’s total sales.
- It helps an analyst ascertain the trend concerning the percentage share of each item on the income statement and its impact on the company’s net income.
- 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 the percentage of total sales.
Some disadvantages of the concept are also given below. Let us understand them in details.
- 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 year after year preparation of a particular company’s income statement is not consistent, then performing any comparative study of common size statement income statements may end up being misleading.
- It does not help in the decision-making process as there is no approved standard proportion of the income statement component as a percentage of total sales.
- In case there is a lack of consistency in preparing the financial statements due to changes in accounting principlesAccounting PrinciplesAccounting principles are the set guidelines and rules issued by accounting standards like GAAP and IFRS for the companies to follow while recording and presenting the financial information in the books of accounts., concepts, and conventions. A common-size income statement becomes quite irrelevant.
- It is impossible to ignore the effects of window dressingEffects Of Window DressingWindow dressing in accounting refers to the intentional manipulation of financial statements by company management in order to present a more favourable picture of the company to users of the financial statement before it is released to the public. in financial statements. However, it fails to figure out the same to provide the actual effect of each expense accountExpense AccountExpense accounting is the accounting of business costs incurred to generate revenue. Accounting is done against the vouchers created at the time the expenses are incurred. 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 precise information to the financial users of the statement.
Frequently Asked Questions (FAQs)
A vertical common size income statement is a financial statement that expresses each item as a percentage of total revenue. Doing so allows for easy comparison of different expense categories and helps identify trends in the company’s income statement over time.
A horizontal common-size income statement is a financial statement that compares the percentage change of each item from one period to another. It helps identify the relative importance of different income statement items and highlights company performance changes over time.
A comparative income statement compares the financial performance of a company over two or more periods, typically showing line-by-line changes in revenue, expenses, and net income. On the other hand, a common-size income statement expresses each line item as a percentage of a base value, such as total revenue, to highlight the relative importance of different income statement components.
This article has been a guide to what is Common Size Income Statement. We explain it with examples, how to calculate, how to interpret and advantages. You may learn more about from the following articles –