What is Common Size Income Statement Analysis?

The term “common size income statement” refers to presenting all the line items in an income statement 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.

  • 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.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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Examples of Common Size Income Statement Format

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

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.

Common Size Format of Colgate’s Income Statement

  • 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.read more 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 / EBTread more 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%.

Advantages of Common Size Income Statement Analysis

  • 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.read more 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.

Disadvantages

  • 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.

Limitation

  • 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.read more, 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.read more 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.read more 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.

Conclusion

In conclusion, it can be said that the 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.

This article has been a guide to Common Size Income Statement. Here is the Common Size Income Statement analysis, its format with excel examples, advantages, disadvantages, and limitations. You may learn more about from the following articles –

  • Operating Income InterpretationBasics of Income StatementComparative Income Statement