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# How to create a common-size income statement

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A common-size income statement is an income statement where each line item is expressed as a percentage of a base figure. This is usually total revenues or total sales. A common-size income statement serves a similar purpose to financial ratio analysis. It facilitates like-for-like comparisons across time periods, companies and industries.

## How to create a common-size income statement?

A common-size income statement is usually created alongside a regular income statement. The top line on the income statement provides the base figure for the calculations. All other line items are expressed as a percentage of the base figure.

Sporty Shoes Income Statement:

 Sales Revenue £100K 100% Cost of Goods Sold £50K 50% Gross Profit £50K 50% Selling, general and administrative expense £10K 10% Operating Profit £40K 40% Taxes £10K 10% Net Income £30K 30%

## Common-size income statement interpretation

Assume Sporty Shoes has just completed its first year of trading. This means that the above income statement is the only one it has. Even so, creating a common-size income statement can still have a lot of value.Â

For instance, in the above set of figures, the common-size income statement format makes it clear that the company is spending 50% of its sales revenue on producing goods. Taken in isolation, itâ€™s impossible to say whether or not this is good, bad or indifferent.Â

It is, however, possible to say that these figures reflect the cost of materials, labour and inventory management. Therefore, Sporty Shoes should look at these areas to see if it is getting the best value for its money.

## Common-size income statement vertical analysis - example A

The real value of a common-size income statement comes when you can compare it to other income statements. For example, Sporty Shoesâ€™ main competitor is Trendy Trainers. Trendy Trainers has also prepared a common-size income statement for the same year.

Trendy Trainers Income Statement:

 Sales Revenue £100K 100% Cost of Goods Sold £45K 45% Gross Profit £55K 55% Selling, general and administrative expense £5K 5% Operating Profit £50K 50% Taxes £15K 15% Net Income £35K 35%

Comparing these two income statements reveals two significant red flags. The first is the cost of goods sold. The second is the selling, general and administrative expenses.

At first glance, the cost of goods sold may not look like a serious concern. There is only a 10% difference between what Sporty Shoes is paying and what Trendy Trainers is paying. The problem is that the cost of goods sold is a significant expense for both companies. This means that even small differences can mount up quickly.

There should also be huge concern about the difference in the selling, general and administrative expenses. Sporty Shoes is paying a massive 50% more than Trendy Trainers. The figures involved are smaller so the impact is less. It should, however, still be investigated as a priority.

## Common-size income statement vertical analysis - example B

Sporty Shoes has now completed its second year of trading and publishes its accounts:

 Sporty Shoes Income Statement Y1 Y1 Y2 Y2 Sales Revenue £100K 100% £200K 100% Cost of Goods Sold £50K 50% £120K 60% Gross Profit £50K 50% £80K 40% SG&A expense £10K 10% £10K 5% Operating Profit £40K 40% £70K 35% Taxes £10K 10% £20K 10% Net Income £30K 30% £50K 25%

There is mixed news here. On the one hand, Sporty Shoes has doubled its sales revenue. On the other hand, the cost of goods sold has also increased, not just in absolute terms but also as a percentage of revenue. This is a clear red flag. On the plus side, Sporty Shoes has reduced its selling, general and administrative expenses.Â

Here, however, are Trendy Trainersâ€™ accounts over the same periods:

 Sporty Shoes Income Statement Y1 Y1 Y2 Y2 Sales Revenue £100K 100% £200K 100% Cost of Goods Sold £45K 45% £110K 55% Gross Profit £55K 55% £90K 45% SG&A expense £5K 5% £10K 5% Operating Profit £50K 50% £80K 40% Taxes £15K 15% £40K 20% Net Income £35K 35% £40K 20%

This shows that Sporty Shoesâ€™ increased cost of goods is not as bad as it first appeared. It could be that at least a part of it was due to factors beyond its control. For example, weather conditions might have reduced the production of a raw material it needs and hence increased the price.

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