by A common size income statement is an income statement in which each line item is expressed as a percentage of the value of revenue or sales. It is used for vertical analysis, in which each line item in a financial statement is represented as a percentage of a base figure within the statement.
Common size financial statements help to analyze and compare a company’s performance over several periods with varying sales figures. The common size percentages can be subsequently compared to those of competitors to determine how the company is performing relative to the industry.
- In financial statement analysis, it is used to compare companies that operate in the same or different industries or to compare the performance of the same company over different time periods.
- Further, it helps a financial analyst establish a relationship between each of the accounts in the income statement and the total sales and eventually helps ascertain how each of the accounts affects the total profitability.
- From an investor’s perspective, it gives a clear picture of the various expense accounts, which are subtracted from the total sales to generate the net income.
Advantages
- It helps in assessing the trend in each line item of the income statement w.r.t. across time periods. Any unusual variation can be easily identified through this technique.
- It can facilitate comprehending the impact of all line items of the income statement on the company’s profitability as it expresses them in terms of the percentage of total sales.
- It can be used to compare the financial performances of different entities irrespective of the scale of operation as it is expressed in terms of percentage.
Disadvantages
- Some of the experts find common size income statements to be useless as there is no approved standard benchmark for the proportion of each item.
- A comparative study based on a common size income statement will be misleading if there is a lack of consistency in its method of preparation.
Limitations
- It does not facilitate the decision-making process due to the lack of any approved standard benchmark.
- One can’t write-off the risk of window dressing of financial statements as the actual figures are not required since the analysis is limited to percentage.
- At times it also fails to identify the qualitative elements during the evaluation of the performance of a company.
- It can be misleading for a business that is impacted by seasonal fluctuations.
