How to Prepare a Common Size Income Statement

A common size income statement presents each line item as a percentage of a base figure, typically total revenues or sales. This allows for a standardized view of a company’s financial performance. Its purpose is to facilitate comparisons that might otherwise be obscured by differences in company size or absolute dollar figures. This analytical tool enables evaluation of a business’s operational efficiency and cost structure over time and against competitors.

Components of a Standard Income Statement

A standard income statement serves as the starting point for preparing a common size income statement. This financial document outlines a company’s revenues and expenses over a specific period, leading to its net income or loss.

The topmost line item is Revenue, representing the total income generated from sales of goods or services. Following this is the Cost of Goods Sold (COGS), which includes the direct costs associated with producing those goods or services. Subtracting COGS from Revenue yields Gross Profit, indicating the profitability of a company’s core operations before other expenses.

Below gross profit, Operating Expenses are listed, encompassing costs not directly tied to production, such as selling, general, and administrative expenses, and research and development. These expenses are deducted to arrive at Operating Income, reflecting profitability from regular business activities. Further deductions for interest and taxes lead to Net Income, the final profit figure. Each of these components provides insights into a company’s financial health, and their transformation into percentages highlights their proportional impact on overall revenue.

Calculating Common Size Percentages

Converting a standard income statement into a common size one involves a straightforward calculation for each line item. The process begins by designating Net Sales (or Revenue) as the base figure, which will always represent 100%. This establishes a consistent reference point for all other financial elements. Each individual line item on the income statement is then divided by this Net Sales figure and multiplied by 100 to express it as a percentage.

For instance, if a company has Net Sales of $1,000,000, and its Cost of Goods Sold is $400,000, the common size percentage for COGS would be ($400,000 / $1,000,000) \ 100 = 40%. Similarly, if Operating Expenses amount to $300,000, their common size percentage would be ($300,000 / $1,000,000) \ 100 = 30%. This calculation is applied consistently down the entire income statement, from Gross Profit to Net Income.

The resulting common size income statement will display each expense and profit component as a percentage of total sales. For example, Gross Profit might be 60%, Operating Income 20%, and Net Income 10%. This presentation clearly illustrates how each dollar of revenue is allocated across different cost categories and what percentage ultimately translates into profit.

Interpreting the Common Size Statement

Once a common size income statement is prepared, its true value emerges through interpretation, offering insights into a company’s financial performance. One significant application is trend analysis, which involves comparing common size percentages across different reporting periods, such as year-over-year or quarter-over-quarter. Observing changes in percentages, like a rising Cost of Goods Sold percentage, can signal increasing production costs, potentially impacting profitability. Conversely, a decreasing percentage for a particular expense might indicate improved efficiency.

Industry benchmarking is another interpretive use, where a company’s common size percentages are compared against industry averages or direct competitors. This comparison helps assess a business’s relative performance and operational efficiency. For example, if a company’s operating expenses are consistently higher as a percentage of revenue compared to industry peers, it may suggest areas where cost controls or operational adjustments are needed to align with competitive standards.

The common size statement also assists in identifying specific strengths and weaknesses within a company’s financial structure. A consistently high gross profit margin, for instance, could indicate strong pricing power or efficient production processes. Conversely, a declining net income percentage might prompt an investigation into rising expenses or declining revenue generation relative to costs.