Common-size income statements provide a tool for analyzing a company’s historical performance over multiple periods (quarters or years). Learn how a common-size income statement also allows for the comparison of individual line items to competitors in addition to serving as a useful tool for comparing a company’s performance over multiple years. Understand the ways in which it helps investors determine how a business is performing within its own industry.
Definition and Example of Common-Size Income Statement
A common-size income statement expresses all revenue and expenses as a percentage of total sales or revenue. Investors may use common-size income statements to help them identify trends or anomalies, either positive or negative. To find the value of any line item from the income statement for a common-size income statement you divide that line item by the total revenue. A common-size income statement is used to complete what is known as vertical analysis, which is when line items on a financial statement are compared to other line items, generally listed as a percentage. Here is a hypothetical example of how some line items might look on a common-size income statement for three successive years.
How a Common-Size Income Statement Works
A common-size income statement can help company leaders and investors determine what is driving profits or dragging on them. Decisionmakers can compare key percentages from year to year or over several years to identify trends that can indicate what may be beneficial to the bottom line or what may be weighing on profits.
Understanding the Example Chart
For example, the information in the chart above may cause this company’s leaders to explore why the cost of goods sold jumped by more than 4.5% in the most recent year, as that can affect profits. In this case, a supply issue may have pushed the cost of materials up temporarily. 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. Gross profits in the example are steady through the three years, while wages decreased in 2020 from 2019, but increased again in 2021. That could be, for example, a result of layoffs and rehiring. Overall, total operating expenses in this scenario dropped by more than 3 percentage points in 2020 and then increased again in 2021. If this company’s leaders can dig deeper and identify ways to keep expenses closer to the 2020 total in future years, it can potentially increase gross profits.
Pros and Cons of Common-Size Income Statements
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. Here are some advantages and disadvantages of using common-size income statements.
Pros Explained
Summarizes key figures: Converting key figures into percentages of revenue allows investors to understand the various line items beyond just numbers, which assists in comparing year over year or different companies. It can be easier to identify trends when they are listed as a percentage of total revenue. Helps compare companies of different sizes: Because line items are listed as a percentage of total revenue, it is easier to compare the financials of, say, a $1 billion company with the financials of a smaller company.
Cons Explained
Lack of information: A common-size income statement may not provide enough important information to conduct a thorough analysis. For example, it will lack information regarding the company’s industry, competitive considerations, leadership changes, governance, and more.No explanations: Common-size income statements don’t provide explanations for significant differences in line items from one year to the next. Does not identify non-financial factors: Many factors that can impact long-term success are not identified on income statements, so investors would need to conduct more research to learn this information.
What It Means for Individual Investors
For investors, analyzing a common-size income statement allows them to identify significant changes or trends in a company’s income and other financials. These statements can provide helpful tools to determine if a company is trending in the right direction and for comparing businesses of different sizes. Common-size income statements can also benefit company leaders. However, financial statements may not provide all the information an investor or company leader needs. So, consider conducting research beyond a company’s financial statements as well.
