Unlocking Financial Insights- A Step-by-Step Guide to Preparing a Common Size Income Statement

How to Prepare Common Size Income Statement

The common size income statement is a financial statement that presents all income statement items as a percentage of sales revenue. This type of financial statement is used to analyze the composition of a company’s income statement and identify trends over time. Preparing a common size income statement involves several steps that are crucial for accurate financial analysis. In this article, we will discuss how to prepare a common size income statement and its significance in financial analysis.

Understanding the Common Size Income Statement

Before diving into the preparation process, it is essential to understand what a common size income statement represents. A common size income statement converts all income statement items into percentages of total sales revenue. This allows for easier comparison between companies of different sizes and across different periods. By viewing financial performance as a percentage of sales, investors and analysts can quickly identify which items are contributing most to a company’s profitability.

Steps to Prepare a Common Size Income Statement

1. Gather the income statement data: Begin by collecting the income statement data for the specific period you wish to analyze. This includes sales revenue, cost of goods sold, gross profit, operating expenses, interest expense, taxes, and net income.

2. Calculate the percentage of each item: Divide each income statement item by the total sales revenue and multiply by 100 to get the percentage. For example, if a company has $500,000 in sales revenue and $200,000 in cost of goods sold, the cost of goods sold percentage would be (200,000 / 500,000) 100 = 40%.

3. Present the common size income statement: Create a new table with the income statement items as the headers and the calculated percentages as the values. This table will show the composition of the income statement as a percentage of sales revenue.

4. Analyze the common size income statement: Once you have prepared the common size income statement, analyze the percentages to identify trends and areas of concern. For example, if the cost of goods sold percentage is increasing over time, it may indicate that the company is becoming less efficient in managing its inventory or production costs.

Significance of the Common Size Income Statement

Preparing a common size income statement has several benefits for financial analysis:

1. Comparison: It allows for easy comparison between companies of different sizes and across different periods, making it an essential tool for benchmarking.

2. Trend analysis: It helps identify trends in a company’s financial performance over time, allowing for better decision-making.

3. Identifying strengths and weaknesses: It highlights areas where a company may be underperforming or excelling, enabling management to focus on the most critical issues.

4. Enhanced communication: It provides a clear and concise representation of a company’s financial performance, making it easier for stakeholders to understand and evaluate.

In conclusion, preparing a common size income statement is a valuable tool for financial analysis. By converting income statement items into percentages of sales revenue, it provides a clearer picture of a company’s financial performance and aids in identifying trends and areas of concern. Following the steps outlined in this article will help you prepare a common size income statement and enhance your financial analysis skills.