A common size income statement is a financial statement that provides data on each account in terms of a percentage of the net value of sales. This approach makes it easier to compare what impact each account is having on the profit earned by the business in any given period, as well as compare different periods with relative ease. This type of statement also makes it easy to compare and contrast accounts between two companies that are considering a merger or some other type of acquisition.
The components or line items on a common size income statement typically provide a breakdown by classification of the total cost of goods sold versus the total amount of sales. The idea is to identify the percentage of those total sales that are consumed in the production process and determine the percentage of gross profit that remains. Ideally, comparison of this data from one period to the next will indicate that the business is maintaining a healthy percentage of gross profit, or at least generating a higher gross profit than for the same period in previous years.
Along with the cost of goods sold, a common size income statement will also consider operating expenses that have some impact on the net profits of the business. Operating expenses are typically segregated into selling expenses and administrative expenses, providing an even clearer picture of how much of the profits are absorbed by these functions. If there is any interest expense connected with the operating income, this is also documented as a percentage. The common size income statement usually ends by identifying the percentage of income before taxes, any applicable taxes to that income, and finally the percentage of income after taxes.
Along with being helpful in comparing data from one period to another, the data found on a common size income statement makes it easy to compare one company operation to a similar company, at least in terms of profitability. This can be important when the two companies are considering a merger, or there is talk of an acquisition of one company by another. Comparing the line items on the statement may provide valuable clues regarding strengths and weaknesses between the two entities, making it easier to determine if the eventual union of the two companies would be a positive event for all concerned.
Companies also sometimes use the data from a common size income statement to measure the company’s performance against the current industry standards. This can often yield clues on which line items appear to be somewhat above industry averages, prompting owners to evaluate those areas more closely. As a result, the comparison may open the door to identifying some processes or procedures that can be updated or otherwise altered, and result in the generation of a higher percentage of net profit.
