Common-Size Analysis: Income Statements
You are working as an analyst for a contract manufacturer. Your business produces two products, toys and video games. You are called in to the boss's office one day and find him looking over income-statement data for the current year and comparing it to last year. He comments that the numbers are large and that it's hard to interpret trends and problem areas. He wants to know if you can help him find a better way to look at all of those numbers.
What would make sense here as a way to present the income statement so that it's easier to interpret?
No.
Since the boss is looking at the income statement, it's more meaningful to use an income-statement item as the common number base. Total assets come from the balance sheet.
Instead, it would make sense to express all of the numbers as a percentage of a common number like total revenue. Total revenue is an income-statement item so it is a better choice for analyzing the income statement.
Good choice!
Total revenue is an income-statement item so it is a better choice for analyzing the income statement.
Expressing numbers as a percentage of a common base is called __common-size analysis__. Revenue is used as the common base for the income statement. Common-size income statements look like the table below.
| Income statement | Current year | Prior year |
|--------------------|--------------|------------|
| Payroll expense | 23% | 18% |
| Executive salaries | 18% | 20% |
| Total Revenue | 100% | 100% |
Notice how the revenue number is always 100 since the base is 100%. The boss is thrilled. "This is easier to read," he says. "I can also see a problem area right away," he adds. "Payroll expense is quite a bit higher than in the prior year."
What might the boss want to do next to isolate his payroll increase?
Good answer.
Common-size analysis works for business segments, too. If we do this, the boss will see where his problem is. Here is the data for the two segments:
| Current year | Toys | Games |
|--------------------|------|-------|
| Payroll expense | 15% | 25% |
| Executive salaries | 18% | 20% |
| Total Revenue | 100% | 100% |
Your boss can easily see where the problem is now. The games segment has a much higher payroll expense than toys does. He plans to head over to the games division this afternoon, and he is letting you knock off early!
To sum it up:
[[summary]]
Not really.
It may be stable for a reason, but that won't help the boss with his payroll problem.
Express all of the numbers as a percentage of a common number like total revenue
Express all of the numbers as a percentage of a common number like total assets
Dig deeper into executive salaries to see why they are so stable
Break the numbers down further into the toys department and games department to see where the payroll increase came from
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