How to Do a Common Size Income Statement
Standardize income statements to gain clear insights into a company's financial structure. Uncover performance trends and facilitate powerful comparisons.
A common size income statement presents each financial line item as a percentage of total revenue, offering a standardized view of a company’s financial performance. This analytical tool transforms absolute dollar figures into relative proportions, facilitating meaningful comparisons. Its purpose is to standardize financial data, allowing for an examination of a company’s cost structure and profitability in relation to its sales. This approach removes the distortion of varying company sizes, making it easier to analyze trends and compare against other entities.
Preparing the Income Statement for Analysis
The initial step in performing a common size analysis involves obtaining a company’s income statement. This financial document summarizes a company’s revenues, expenses, and net income over a specific reporting period. For common sizing, “Total Revenue” or “Net Sales” is the designated baseline figure to which all other line items will be compared.
Calculating Common Size Percentages
Creating a common size income statement involves applying a specific formula to each line item. Divide the dollar amount of each line item by the total revenue, then multiply the result by 100 to express it as a percentage. For example, if a company’s total revenue is $1,000,000 and its Cost of Goods Sold (COGS) is $400,000, the common size percentage for COGS would be 40%. This process is applied consistently down the entire income statement. Spreadsheet software is commonly used to apply this formula to all relevant line items.
Analyzing the Common Size Income Statement
Once the common size percentages are calculated, the resulting statement provides a framework for financial analysis. These percentages allow for a clear assessment of how much of each revenue dollar is allocated to specific costs and how much ultimately contributes to profit. For instance, the Cost of Goods Sold percentage reveals the proportion of revenue directly consumed by production costs. Operating expense percentages, such as those for selling, general, and administrative costs, highlight the efficiency of a company’s day-to-day operations.
Key profitability percentages, including gross profit margin, operating profit margin, and net profit margin, signify the company’s ability to convert revenue into different levels of profit. A gross profit margin, calculated as gross profit divided by revenue, indicates how much revenue remains after accounting for direct production costs. The operating profit margin shows profitability from core operations before interest and taxes. The net profit margin, which is net income divided by revenue, represents the percentage of revenue retained as profit after all expenses.
Common size statements are beneficial for trend analysis, allowing for comparisons of a company’s performance over several periods regardless of changes in sales volume. They also enable effective benchmarking against competitors or industry averages, as the percentage format standardizes financial data across entities of varying sizes.