A common size income statement shows each account as a percentage of net sales value, making it easy to compare the impact of each account on earnings and compare different periods. It can also be used to compare companies and measure performance against industry standards.
A common size income statement is a financial statement that provides data about each account in terms of a percentage of net sales value. This approach makes it easy to compare the impact each account has on the company’s earnings in a given period, as well as compare different periods with relative ease. This type of statement also makes it easy to compare and contrast the 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 generally 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, comparing this data from one period to the next will indicate that the company is maintaining a healthy percentage of gross profit, or at least generating higher gross profit than for the same period in prior years.
Along with cost of goods sold, a common size income statement will also consider operating expenses that have some impact on the net profit of the business. Operating expenses are typically segregated into selling and administrative expenses, providing an even clearer picture of how much profit these functions absorb. If there is any interest expense related to operating income, this is also documented as a percentage. The common size income statement typically ends by identifying the percentage of income before taxes, any taxes applicable to that income, and finally the percentage of income after taxes.
In addition to being useful for comparing data from period to period, the data found on a common size income statement makes it easy to compare a company’s operation with that of 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 lines of the statement can provide valuable clues as to the strengths and weaknesses between the two entities, making it easier to determine whether the eventual merger of the two companies would be a positive event for all involved.
Sometimes companies also use data from a common size income statement to measure company performance against current industry standards. This can often give clues as to which line items appear to be somewhat above industry averages, leading owners to evaluate those areas more closely. As a result, the comparison may open the door to the identification of some processes or procedures that can be updated or otherwise modified, and result in the generation of a higher percentage of net benefit.
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