What Is a Common Size Income Statement? Definition and Examples 2023

Or, if the cost of goods sold is expected to remain at that higher level, the company may want to raise the prices of their product. Other line items may include gains from the sale of capital equipment or real estate and may break out revenue. Operating profit is one of the most important numbers you can analyze because it shows the health of the business firm’s core business. The goodwill level on a balance sheet also helps indicate the extent to which a company has relied on acquisitions for growth. Join over 2 million professionals who advanced their finance careers with 365.

You can use the balance sheet equation, which is assets equals liabilities, plus any stockholders equity. Common-size income statement analysis states every line item on the income statement as a percentage of sales. If you have more than one year of financial data, you can compare income statements to see your financial progress. This type of analysis will let you see how revenues and spending on different types of expenses change from one year to the next.

Common Size Income Statement Definition and Example

1. Charlie is a much bigger retailer for outdoor gear, as Charlie has nearly seven times greater sales than Clear Lake.
2. Also known as the profit and loss statement, the income statement is an overview.
3. A common-size balance sheet is a comparative analysis of a company’s performance over a time period.
4. Recall that a key benefit of common-size analysis is comparing the firm’s performance to the industry.

With regular financial statements, you would have line items listed as their total amounts. When it comes to common size financial statements, each line item gets expressed as a specific percentage of revenue or sales. One of the best examples of a common size financial statement is to take a look at the sales revenue on an income statement. Here, the common size percentages get calculated for each line item, and they’re listed as a percentage of the standard revenue or figure. The balance sheet provides a snapshot overview of the firm’s assets, liabilities, and shareholders’ equity for the reporting period.

Pros and Cons of Common-Size Income Statements

All three of the primary financial statements can be put into a common-size format. Financial statements in dollar amounts can easily be converted to common-size statements using a spreadsheet. For example, some companies may sacrifice margins to gain a large market share, which increases revenues at the expense of profit margin.

Essentially, it allows data entries to be listed as a percentage of a common base figure. This is instead of a traditional financial statement that would list items as absolute numerical figures. The income statement (also referred to as the profit and loss (P&L) statement) provides an overview of flows of sales, expenses, and net income during the reporting period. The income statement equation is sales minus expenses and adjustments equals net income. This is why the common size income statement defines all items as a percentage of sales.

Vertical analysis refers to “looking down” the column of an income statement. Now that you have covered the basic financial statements and a little bit about how they are used, where do we find them? In this next section we will explore the requirements for what needs to be reported, when, and to real estate development model whom. Keep in mind that this example illustrates only part of a traditional income statement converted into a common-size income statement. When comparing any two common size ratios, it is important to make sure that they are computed by using the same base figure.

One of the biggest benefits is that it provides investors with information to see changes in the financial statement of a company. In general, you can prepare a common-size income statement by going line-by-line and dividing each expense as a percentage of sales. A common-size balance sheet is a comparative analysis of a company’s performance over a time period. One company may be willing to sacrifice margins for market share, which would tend to make overall sales larger at the expense of gross, operating, or net profit margins.

Common-Size Assets and Common-Size Liabilities and Equity

Common-size income statements can provide some valuable information to investors and company leaders. However, they may not be enough on their own for a complete analysis of a company’s financial health. A common-size income statement can help company leaders and investors determine what is driving profits or dragging on them. Common size financial statement analysis, which is also called a “vertical” analysis, is a technique that financial managers use to analyze their financial statements.

By looking at this common size income statement, we can see that the company spent 10% of revenues on research and development and 3% on advertising. Although XYZ is much smaller than ABC, its expenses account for a smaller proportion of revenue, and its profit margins (highlighted in green) are higher than ABC’s. The stronger profit performance could myob to xero direct conversion prompt XYZ’s managers to plan for expansion, while possibly encouraging lenders and investors to provide capital. On this income statement, the common size divides each line item by the total revenue. For example, if the cost of goods sold was $50,000 then you would divide it by $100,000 to equal 50%. Even though common size analysis doesn’t provide as much detail, it can still be effective in analyzing financial statements.

If there are any fixed assets that can be sold, management should consider selling them to lower both the depreciation and interest expense on debt. On the other hand, horizontal analysis refers to the analysis of specific line items and comparing them to a similar line item in the previous or subsequent financial period. Although common size analysis is not as detailed as trend analysis using ratios, it does provide a simple way for financial managers to analyze financial statements. The standard figure used in the analysis of a common size income statement is total sales revenue.

How This Differs From Regular Financial Statements

There’s also a separate version of the common size balance sheet where any current asset line items are listed as a percentage of the total assets. It would work the same with liabilities listed as a percentage of total liabilities. It also includes stockholders equity being listed as a percentage of total stockholders equity. A common-size income statement expresses all revenue and expenses as a percentage of total sales or revenue.

Common size financial statements allow for easier analysis of a company’s performance because percentages can be more quickly assessed than large dollar amounts. A common size income statement can make it simpler to compare a company’s performance against competitors, and to spot any significant changes in its expenses and profit margins over time. A common size income statement is a quick and handy way of understanding each line item’s relationship to the top line. Business managers and investors use this type of financial statement to analyze a company’s cost ratios and profit margins—and to compare them to those of other companies. Common sizing is also sometimes used for other financial statements, such as the balance sheet and cash flow statement. Formatting financial statements in this way reduces bias that can occur and allows for the analysis of a company over various periods.

In Figure 5.21, you can see the formulas used to create Clear Lake Sporting Goods’ common-size income statement in Excel. Notice that the $ can be inserted to anchor a cell reference, making it easier to copy and paste the same formula onto many lines or columns. Here is a hypothetical example of how some line items might look on a common-size income statement for three successive years. The income from selling the products or services will show up in operating profit. If it is declining, which is in the case of XYZ, Inc., there is less money for the shareholders and for any other goals that the firm’s management wants to achieve. It is also watched closely by lenders (e.g., banks) when assessing a company’s credit risk.

However, the equity increase was much smaller than the total increase in liabilities of $40,000. Long-term debt increased by only $10,000 by issuing additional notes payable. The remainder of that increase is seen in the 5 percent increase in current liabilities.