What Is Common Size Income Statement?
The common size income statement is a financial statement that presents the income and expenses of a company as a percentage of its total revenue. It is also known as a vertical analysis of the income statement. The purpose of creating a common size income statement is to evaluate the relative importance of each expense or revenue item in relation to the company’s total revenue.
By expressing the income statement items as a percentage of revenue, it becomes easier to compare the financial performance of a company over different periods or against industry benchmarks. It allows analysts and investors to identify trends, patterns, and areas of concern within the income statement. This type of analysis can be useful for decision-making, forecasting, and identifying areas for cost reduction or revenue improvement.
The common size income statement starts with the total revenue as 100% and expresses all other line items as a percentage of this total. The formula to calculate the common size percentage for an income statement item is:
Common Size Percentage = (Line Item Amount / Total Revenue) x 100
For example, if a company has total revenue of $1,000,000 and its cost of goods sold is $400,000, the common size percentage for cost of goods sold would be:
Common Size Percentage = ($400,000 / $1,000,000) x 100 = 40%
The result indicates that cost of goods sold represents 40% of the company’s total revenue.
FAQs about Common Size Income Statement:
1. Why is the common size income statement important?
The common size income statement allows for a better understanding of the composition of a company’s income and expenses. It helps identify trends and patterns, and facilitates comparisons with industry benchmarks.
2. How is the common size income statement different from a regular income statement?
A regular income statement presents the actual dollar amounts of income and expenses, while the common size income statement expresses these amounts as a percentage of total revenue.
3. What are the benefits of using a common size income statement?
The common size income statement helps in identifying areas of concern, evaluating performance over different periods, and making informed decisions regarding cost reduction or revenue improvement.
4. Can the common size income statement be used for benchmarking?
Yes, the common size income statement allows for easy benchmarking against industry standards or competitors. It helps in identifying areas where a company may be over or underperforming.
5. What are some common line items found on a common size income statement?
Common line items include revenue, cost of goods sold, gross profit, operating expenses, net income, and taxes.
6. How can I calculate the common size percentage for an expense item?
Divide the expense item by the total revenue and multiply by 100 to get the common size percentage.
7. Can the common size income statement be used for forecasting?
Yes, the common size income statement can be used to identify trends and patterns, which can help in forecasting future performance.
8. What are some limitations of the common size income statement?
The common size income statement does not provide information about the absolute dollar amounts of income and expenses. It also does not consider the impact of non-operating items or changes in accounting policies.
9. Can the common size income statement be used for a single period analysis?
Yes, the common size income statement is useful for analyzing a company’s financial performance in a single period and identifying areas for improvement.
10. How frequently should a common size income statement be prepared?
A common size income statement can be prepared quarterly, annually, or for any other desired period, depending on the needs of the user.
11. Are there any industry-specific benchmarks available for common size income statements?
Yes, there are industry-specific benchmarks available that can help in comparing a company’s performance with its peers.
12. Can the common size income statement be used by individuals for personal financial analysis?
Yes, the common size income statement can be used by individuals to analyze their personal income and expenses, identify areas for improvement, and make informed financial decisions.
In conclusion, the common size income statement provides a valuable tool for analyzing a company’s financial performance. By expressing income and expenses as a percentage of total revenue, it allows for easy comparisons and trend analysis. The common size income statement is useful for decision-making, forecasting, and benchmarking against industry standards. However, it is important to consider its limitations and use it in conjunction with other financial statements for a comprehensive analysis.
