It allows an analyst to look at how the performance has changed over the period. From an investor’s perspective, a common size income statement helps spot patterns in the company’s performance that a basic income statement may not uncover. The following financial statement items are shown for J&T Manufacturing. Net sales $840,000 Cost of goods sold 360,000 Insurance expense 28,000 Total operating expenses 120,000 Net income 56,000 Calculate the common-size percentage for gross margin. Vertical analysis of comparative income statements would show cost of goods sold as a percentage of a) total assets. LaDanion’s Limos reports net income of $130,000, average total assets of $700,000, and average total liabilities of $340,000.

We’ve now completed our vertical analysis for our company’s income statement and will move on to the balance sheet. The formula to perform vertical analysis on the income statement, assuming the base figure is revenue, is as follows. Performing vertical analysis creates the so-called “common size” income statement and the “common size” balance sheet.

Common Size Analysis

Trend percents are shown on comparative income statements and balance sheets, shown on common-size comparative statements, or also called index numbers. Which of the following is true for common-size comparative statements? Clear Lake Sporting Goods, for example, might compare their financial performance on their income statement to a key competitor, Charlie’s Camping World. Charlie is a much bigger retailer for outdoor gear, as Charlie has nearly seven times greater sales than Clear Lake. Common-size statements allow Clear Lake to compare their statements in a meaningful way (see Figure 5.26).

• This is so because revenues affect nearly every item in an income statement.
• The sum of the current assets equals 50%, confirming our calculations thus far are correct.
• It is only when you pass break-even that profits begin to be generated.
• Using common-size analysis can help you get a quick sense of how the company is doing financially.
• Look back over the past several periods and you may soon spot changes in the size of some line items‘ ratios that reflect problems that need fixing or progress that can be enhanced.
• It can also be very informative when you compare your company’s return on assets with the returns generated by other businesses in your industry.

There are other, more specific, techniques that are used by people and agencies with special interests in certain components of financial statements. Industry statistics are frequently published in common-size form. Focusing on business with capitalizations under $1 million, providing financial ratios and other information. They are the day-to-day expenses that your business will incur regardless of how sales volume is increasing or decreasing. Some examples of fixed expenses include overhead, administrative costs, rent, salaries, office expenses, and depreciation. There isn’t an „industry standard“ presentation, but typically, you would display a balance sheet with the actual numbers on the left, and the corresponding percentages on the right. To reiterate from earlier, dividing by total assets is akin to dividing by the sum of liabilities and equity.

Step 3. Vertical Analysis of Balance Sheet

Using measures to assess a business’s ability to pay its current liabilities is called current position analysis. Factors which reflect the ability of a business to pay its debts and earn a reasonable amount of income are referred to as solvency and profitability. David Kindness is a Certified in a common-sized income statement, each item is expressed as a percentage of net income. Public Accountant and an expert in the fields of financial accounting, corporate and individual tax planning and preparation, and investing and retirement planning. David has helped thousands of clients improve their accounting and financial systems, create budgets, and minimize their taxes.

Your accountant or banker may have access to these or other compilations of ratios for your industry. In general, your company’s gross profit margin ratio should be stable. It should not fluctuate much from one period to another, unless the industry your company is in is undergoing changes which affect the costs of goods sold or your pricing policies. The gross margin is likely to change whenever prices or costs change.

Chapter17: Analysis of Financial Statements

This discussion also provides you with a detailed example of a common-size income statement and other procedures you can use to examine your company’s profitability. If your company’s return on assets ratio is lower than those of other companies, this may indicate that your competitors have found ways to operate more efficiently. If your company’s current return on assets is lower than it was a year ago, you should look at what has changed in the way your company is using its resources. Now, let’s calculate the level sales must reach to achieve break-even. To do it, we will find what percentage current variable expenses are of total sales. O ne of the most effective way for you to use common size ratios as a management tool is to prepare them on a regular basis and compare the ratios from one period to another.