What is a Common Size Income Statement?
A common size income statement is one that has an additional column showing each monetary amount as a percentage of the revenue (sales) of the business. The common size income statement is not required by Accounting Standards, and is used more as a management tool rather than a formal reporting document.
There is no set format to the common size income statement, but it is best to keep the same income statement format required by accounting standards, and then add an additional column to the right representing the percentage of revenue.
Example of Common Size Income Statement
A typical layout is shown in the example below. This example shows a vertical common size income statement with the right hand column showing each line item as a percentage of revenue.
|Cost of sales||37,288||77.6%|
|Research and development||1,909||4.0%|
|Sales and marketing||6,216||12.9%|
|General and administrative||658||1.4%|
|Income before tax||934||1.9%|
|Income tax expense||291||0.6%|
In a common size income statement the right hand column shows each line item as a percentage of the revenue. For example, operating expenses are shown in the income statement at a value of 8,783, and the revenue is shown as 48,077. As a percentage, operating expenses represents 8,783/48,077 = 18.3% of revenue.
Comparative Common Size Income Statement Analysis
Common size income statement analysis allows a business to perform a number of tasks as follows:
To show what proportion each item represents of the revenue of the business.
In the above example, gross margin is shown as being 22.4% of the revenue. This percentage is in fact the gross margin percentage which is a measure of the level of true income a business generates on its revenue, and used to calculate the break even sales.
To analyze changes in the income statement of the business over time.
By producing a common size income statement at the end of each accounting period, it is possible to monitor changes in each line item over time. For example, the following shows the vertical common size analysis for two accounting periods.
The business has grown over the two accounting periods and the absolute values of most line items are significantly higher. However, despite this growth, the business made more net income in 2018 than it did in the 2019. A quick look at the common size income statement in the right hand percentage columns, shows that the gross margins remained similar 22.4% and 22.3%, but that operating costs increased from 16.1% to 18.3%, which together with the increase in depreciation going from 1.6% to 2.1%, resulted in a lower net income for 2019.
The conclusion from the common size income statement analysis is that the operating expenses have increased dis-proportionally to the level of growth and need to be closely monitored to find the causes.
By monitoring the trend of the common size income statement percentage for each line item, it is easy to spot changes which may need correcting.
To make comparisons of the business with other businesses irrespective of their relative size.
A similar process to that used above can be applied to compare two different businesses. In the example below. the common size income statements are for two different businesses of differing sizes.
These two businesses are dissimilar in size and nature, it is difficult to compare the absolute values shown in the income statement. The common size income statement, however, shows why the two businesses differ. The second business has a much higher gross margin (40.5% compared to 22.4%), and maintains its operating expenses at 8.0% instead of 18.3%. Despite a significantly higher tax percentage (7.7% compared to 0.6%), business two shows a net income off 23.9% of revenue compared to business one which shows just 1.3%.
This example is of two business in two very different industries and the common size income statement clearly highlights the differences irrespective of their relevant size.
The comparison could equally be done between the business and a competitor in the same industry or with industry averages, thereby highlighting any differences in operation which may need correcting. For example if the common size income statement shows that your sales and marketing expense is 2% of revenue compared to industry average of say 9%, it could indicate that you are under budgeting on sales and marketing spend, and need to increase the level in order to fuel growth.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.