What Is a Common Size Income Statement?
Unlock deeper financial understanding. Learn how standardizing income statement data reveals proportional relationships, enabling clearer insights into a company's performance and comparisons.
An income statement details a company’s revenues and expenses over a specific period. While a traditional income statement presents these figures in absolute dollar amounts, a common size income statement transforms them into percentages. This transformation offers a different perspective, highlighting proportional relationships within the statement and serving as an analytical tool.
What a Common Size Income Statement Is
A common size income statement expresses every line item as a percentage of net sales, also referred to as total revenue. This approach standardizes the financial statement, allowing for a clear view of how much of each sales dollar is consumed by various expenses and how much remains as profit. For instance, instead of seeing a dollar figure for the cost of goods sold, you see it as a percentage of the total revenue generated. This conversion shows the proportion of each expense or income item relative to the total revenue.
How to Create a Common Size Income Statement
Creating a common size income statement involves a straightforward calculation. Net sales or total revenue serve as the base figure, representing 100%. Each subsequent line item on the income statement is then divided by this net sales figure and multiplied by 100 to convert it into a percentage.
For example, if a company has net sales of $1,000,000 and a cost of goods sold (COGS) of $400,000, the common size percentage for COGS would be ($400,000 / $1,000,000) 100 = 40%. Similarly, if operating expenses are $200,000, they would represent ($200,000 / $1,000,000) 100 = 20% of net sales.
Interpreting the Data
Interpreting a common size income statement involves analyzing percentages to understand financial relationships within a company. A high percentage for cost of goods sold (COGS) indicates a large portion of sales revenue is used to produce goods, potentially suggesting lower efficiency or higher production costs. Conversely, a declining COGS percentage might signal improved production efficiency or better purchasing agreements.
The gross profit percentage (net sales minus COGS) shows the profit margin before operating expenses. This indicates effective management of direct production costs.
Operating expenses, as a percentage of sales, reveal the proportion of revenue consumed by daily operations like administrative and selling costs. A rising percentage for these expenses could point to inefficiencies or increased overhead.
The net income percentage (net profit margin) shows the proportion of sales revenue remaining after all expenses, including taxes, have been deducted. This percentage reflects the company’s overall profitability from each dollar of sales.
Key Applications of Common Size Analysis
Common size analysis offers insights for various financial assessments. One primary application is facilitating industry comparisons. By converting figures to percentages, it allows for meaningful comparisons between companies of different sizes within the same industry, neutralizing the impact of absolute dollar differences. This means a small local business can be compared to a large national corporation, revealing relative strengths and weaknesses.
The analysis is also valuable for trend analysis within a single company over multiple periods. Comparing common size statements from different years helps identify shifts in cost structure, revenue allocation, and overall profitability. For example, a consistent increase in the selling, general, and administrative expense percentage might highlight a growing cost problem. Common size statements are also instrumental in benchmarking a company’s performance against industry averages or direct competitors, providing context for its financial health and operational efficiency.