Definition
A Common Size Income Statement is a financial report that presents all items in percentage terms of revenue instead of absolute values. It makes it easier to compare the financial performance of different companies regardless of their size, or compare different periods of a single company. Each line item on this statement is expressed as a percentage of gross sales or revenues.
Phonetic
The phonetics of “Common Size Income Statement” are:Common: /ˈkɒmən/Size: /saɪz/Income: /ˈɪnkʌm/Statement: /ˈsteɪtmənt/
Key Takeaways
- Comparison Across Companies: The Common Size Income Statement enables analysts and investors to compare companies of different sizes in the same industry. It highlights the variability of costs and provides a detailed measure of cost behavior.
- Standardized Financial Information: It standardizes financial information. While the dollar amounts for various income and expense accounts can vary significantly from company to company, the percentages calculated in a common size income statement can provide valuable insight, as they are in a ‘common’ format.
- Trends Analysis: Common Size Income Statements can reveal trends over time when multiple periods are presented and analyzed. It can show changes in a company’s financials across the years, and help predict patterns for the future.
Importance
A Common Size Income Statement is important in business/finance as it expresses each line item on the company’s income statement as a percentage of total sales or revenue. This allows for easier comparison and analysis across different periods of the company’s performance or against competitors, irrespective of size. The common size income statement can highlight trends or anomalies which may not be initially apparent in a standard income statement. Its relative approach to financial data aids in understanding the proportionate impact of each expense category on the company’s profitability, thus providing valuable insights for strategic planning and decision-making.
Explanation
The Common Size Income Statement is a financial tool that is primarily used for a comprehensive intra and inter-company analysis. Its main purpose is to express all the figures on the income statement as a percentage of a particular item that is vital in providing useful analysis, often it is revenues or sales. This helps in identifying trends and patterns in the data, showing uniform proportional relationships, and providing deep insights about costs, expenditures, and profits relative to sales over several accounting periods. For example, if a business is reviewing their annual income statement, the common size statement would represent all items in terms of their percentage contribution to total revenue. This helps to easily compare the performance of various cost and profit centers within a business, assess relative effectiveness, and monitor changes over time in these areas. Furthermore, this format enables more accurate comparison not only internally but also with other firms irrespective of their size. Therefore, by converting actual figures into percentages, the common size income statement offers proportional clarity that facilitates effective strategic planning and decision-making.
Examples
1. Coca-Cola Company: The company utilizes common size income statements to compare their performance over different years. With this, they calculate each item on the income statement as a percentage of their revenue. These percentages help to quickly identify any changes in the cost strategy, gross margin, or operating profit margin, which is much harder to discern from the raw data.2. Alphabet Inc.: Alphabet Inc., the parent company of Google, uses common size income statements to analyze its business operations over different geographical locations. For instance, it shows the percentage of total revenue generated by each location, the cost of revenue, research and development expenses etc., as a percentage of total revenue of that particular location. This approach could be useful when the company wants to focus on better performing regions or improve operations in certain locations.3. Amazon Inc.: Amazon Inc. uses common size income statements to assess performance across different business segments such as online retail, cloud computing, and digital advertising. By presenting each expense item as a percentage of revenue for each segment, the company can identify, for example, which segment has higher operating costs or where margins can be improved. This way, the company can make strategic decisions about resource allocation across different segments.
Frequently Asked Questions(FAQ)
What is a Common Size Income Statement?
A Common Size Income Statement is a type of financial statement that displays all items as percentages of a common base figure rather than just as absolute numerical figures. It’s a useful tool for analyzing and comparing companies of different sizes or within different industries.
What is the purpose of a Common Size Income Statement?
This income statement provides a detailed analysis of the cost structure and the profitability of different business functions, making it easier to compare the performance of differing firms or examine a firm’s performance over time.
How is a Common Size Income Statement created?
A common size income statement is created by taking each line item on the income statement and comparing it to revenue, which is set as 100%. Each item is then displayed as a percentage of the total revenue.
What are some advantages of using a Common Size Income Statement?
It simplifies the comparison of financial statements of businesses of varying sizes. This type of statement allows for easy analysis of income statements across periods for changes in relative magnitude. It can indicate trends and provide important insights about a company’s cost structure and profitability.
Can Common Size Income Statements be used for internal analysis?
Yes, they are often used for internal comparison over different periods to identify trends or significant changes in an organization’s financial performance.
What kind of insights can a Common Size Income Statement provide?
It can provide insights into a company’s cost structure, profit margins, and areas consuming a disproportionate share of revenue. The data presented can then be used to make adjustments and strategies for business improvement.
How does a Common Size Income Statement differ from a traditional income statement?
While they contain the same information, a traditional income statement contains only absolute numbers. A common size income statement converts these numbers into relative percentages, making comparison more straightforward.
Related Finance Terms
- Percentage Analysis: It is the process of deriving the percentage of each item in the total income or expenditure, which is the basic concept of a common size income statement.
- Comparative Financial Analysis: It is a study reflecting the similarities and discrepancies in the amounts of the corresponding items within the same row of a common size income statement.
- Profit Margin Ratios: This is a way to evaluate a company’s performance derived from the common size income statement, such as gross profit margin, operating profit margin, and net profit margin.
- Financial Benchmarking: It’s a process of evaluating the company’s financial figures against industry peers or competitors, which is often performed using common size income statements.
- Standardized Financial Statements: These are statements where all items are expressed as a percentage of a certain value, such as sales, making it easy to compare with other companies or other periods. Common size income statement is one type of standardized financial statements.
