How is a common-size income statement prepared?
A common-size income statement is a financial statement that presents all items as a percentage of sales revenue. It is a useful tool for analyzing a company’s financial performance and comparing it with other companies in the same industry. The preparation of a common-size income statement involves several steps that are essential for understanding the financial health of a business. In this article, we will discuss how a common-size income statement is prepared and its significance in financial analysis.
The first step in preparing a common-size income statement is to gather the necessary financial data. This includes the company’s income statement for the period being analyzed, as well as the sales revenue figure. The income statement typically includes items such as revenue, cost of goods sold, gross profit, operating expenses, and net income.
Step 1: Calculate the percentage of each item
Once the financial data is collected, the next step is to calculate the percentage of each item on the income statement relative to sales revenue. This is done by dividing each item by the sales revenue and multiplying the result by 100 to get a percentage. For example, if the cost of goods sold is $500,000 and the sales revenue is $1,000,000, the percentage of cost of goods sold would be (500,000 / 1,000,000) 100 = 50%.
Step 2: Present the items as a percentage of sales
After calculating the percentage of each item, the next step is to present the income statement with each item as a percentage of sales. This can be done by creating a new income statement that lists each item as a percentage of sales, rather than as a dollar amount. This allows for easier comparison between different companies and over time.
Step 3: Analyze the common-size income statement
Once the common-size income statement is prepared, it can be used to analyze the financial performance of the company. By looking at the percentages of each item, it is possible to identify trends and areas of concern. For example, if the percentage of cost of goods sold is increasing over time, it may indicate that the company is experiencing higher production costs or inefficiencies in its supply chain.
Step 4: Compare with industry benchmarks
Another important use of the common-size income statement is to compare a company’s financial performance with industry benchmarks. By comparing the percentages of each item on the common-size income statement with those of other companies in the same industry, it is possible to determine how the company is performing relative to its peers.
Conclusion
In conclusion, a common-size income statement is a valuable tool for financial analysis that allows for easier comparison and trend analysis. By preparing a common-size income statement, businesses can gain a better understanding of their financial performance and make informed decisions to improve their operations. The process of preparing a common-size income statement involves calculating the percentage of each item relative to sales revenue, presenting the items as a percentage of sales, analyzing the statement, and comparing it with industry benchmarks.
