What is a 'Common Size Income Statement'
Common size income statement is an income statement in which each account is expressed as a percentage of the value of sales. This type of financial statement can be used to allow for easy analysis between companies or between time periods of a company. Common size income statement analysis allows an analyst to determine how the various components of the income statement affect a company's profit.
BREAKING DOWN 'Common Size Income Statement'
There are three different financial statements that investors can access: the balance sheet, the cash flow statement and the income statement. The balance sheet provides an overview of assets, liabilities and equity. The cash flow statement provides an overview of the sources and uses of cash. The income statement is perhaps the most popular statement because it provides a summary of company revenues and expenses. The challenge for some analysts and investors is interpreting the income statement. The common size income statement can help with this.
Common Size Income Statement
The income statement is generally provided as a comparison against previous time periods. It always starts with revenues and sales and ends with net income or earnings per share. In between, investors have a chance to see how much each expense deducts from revenue to arrive at net income. In this way, analysts are able to provide a variance analysis against prior periods. A company with an increase in revenue is doing well but only if it can grow sales at a faster rate than expenses. One tool analysts use to understand how much expenses are changing as a percentage of revenue is by using the common size income statement.
Example and Usage
Company A has an income statement with four different line items, revenue, cost of goods sold, salaries and net income. Net income is calculated by subtracting the cost of goods sold and salaries from revenue. If revenue is $100,000, cost of goods sold is $50,000, and salaries are $25,000, then net income is $25,000. The common size version of this income statement is to divide each line item by revenue, or $100,000. Revenue divided by $100,000 is 100%. Cost of goods sold divided by $100,000 is 50%. Salaries divided by $100,000 is 25%, and net income divided by $100,000 is also 25%. This tells us that the cost of goods sold takes up 50% of revenues as opposed to 25% of revenues like salaries. Large changes in the percentage of revenue used by different expense categories over a given period of time could be a sign that the business model is changing.