6. Common-Size Income Statement

 
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Overview

The common-size income statement can provide some valuable insights, not noticed when looking at absolute numbers. Find out how to create one in this lesson.

Lesson Notes

Common-Size Income Statement

- Provides the ability to view a company's cost base through a different lens
- Calculated by dividing all entries on the income statement by annual revenue
- Enables an analyst to quickly see which costs are growing disproportionately
- Pay particular attention to growing operating costs

EBIT Margin

- A common profitability metric used in financial analysis
- EBIT = Earnings before Interest and Taxes
- EBIT Margin = EBIT / Revenue

Transcript

The Common Size Income Statement is a technique used to see how much each expense deducts from revenue to arrive at net profit. Using the Common Size Income Statement, analysts are able to perform a variance analysis against historical years, easily comparing performance against peers, and monitoring how the economics of a company's market or business model is changing. To create the Common Size Income Statement, we start by removing any percentages we currently have inserted in the Income Statement. To save some time, I'll now do this off camera. Next, I'll copy the years at the top of the page, and paste a couple of columns over to the right, with Ctrl + V.

Now I can perform my common sizing. So in the top left-hand corner, I'll take the corresponding cell, and divide by revenue.

And I'll anchor this revenue, and I'll copy across with Ctrl + R. And copy all the way down with Ctrl + D. I'll convert to percentage, perform some formatting off camera, including removing the zero percents, and now you can see, I have my common income statement ready to go. To make the screen easier to read, I'm going to hide the initial Income Statement. So I'll select this column, select all of the columns for the original Income Statement, group with Alt + A, G, G, and then hide with Alt + A, H.

I'm now ready to analyze my Common Size Income Statement. The first observation to note is how consulting revenue will soon become the main revenue generator for MarkerCo From 2012 to 2015, it went from 31% to 46% of total revenue. If we look at gross margin, we can also see that it has moved 4% in the last four years. This may be due to the fact that consulting has higher gross margins for MarkerCo than hardware. Operating expenses have stayed relatively consistent over the period, apart from general and administrative. This has risen as a percentage of revenue, and we may want to ask management why this is the case. As we scroll down the page, we can see that the rise in gross profit margin and steady operating expenses has resulted in a higher EBIT margin and net profit margin.

Given that the net profit margin is rising well above 20%, the business appears in great shape. As you can see from this screen, the Common Size Income Statement makes it very easy to quickly evaluate which expenses in the business are growing and falling relative to sales. When analyzing the Income Statement, I would always recommend converting to the common size version, as it makes spotting trends and identifying warnings much, much easier. In this case, we spotted the changing business model of MarkerCo. Growing consulting business is having an impact on gross margins and increasing the profitability of the company. This lesson completes our quick tour of the Income Statement. In the next lesson, we'll move on to the Balance Sheet, where the financial health of the business is evaluated.