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To make an income statement common-size, divide each line by the same period’s revenue and express the result as a percentage. That makes the shares of sales absorbed by costs and retained as profit visible even when companies have different sales volumes. Keep revenue as the denominator throughout the calculation; changing the base midway produces ratios that cannot be read as one statement.
What a common base reveals
A conventional income statement gives amounts. A common-size version holds revenue at the base and restates costs, subtotals and profit against it. CFA Institute describes this as vertical common-size analysis in its financial analysis techniques reading. It can help compare a company across periods or compare businesses of different scale, provided the underlying accounting and business models are considered.
An illustrative statement from top to bottom
Consider this wholly invented statement for one accounting period. All amounts are in millions of currency units; the percentages use revenue of 100 as their common base.
| Revenue | 100 | 100% |
| Cost of sales | 60 | 60% |
| Gross profit | 40 | 40% |
| Operating expenses | 20 | 20% |
| Operating profit | 20 | 20% |
| Interest expense | 5 | 5% |
| Tax expense | 3 | 3% |
| Net profit | 12 | 12% |
Gross profit is revenue less cost of sales, so 100 less 60 leaves 40. After operating expenses of 20, operating profit is 20. Interest of 5 and tax of 3 then leave net profit of 12. The gross, operating and net margins are therefore 40%, 20% and 12% respectively, each divided by the original revenue of 100. These figures demonstrate the method; they are not reported company data.
The denominator trap
A tempting error is to divide operating expenses by gross profit, then tax by profit before tax. Those fractions answer different questions, but they no longer describe a common-size income statement. In the invented example, dividing operating expenses of 20 by gross profit of 40 gives 50%; its common-size amount is 20% of revenue. Write the revenue figure beside every calculation before converting the next line.
A second error is to read a margin change as a full explanation. A larger gross margin could reflect pricing, product mix or classification, among other causes; the percentage alone does not decide which. CFA Institute includes evaluation of performance using common-size income statements in its income-statement learning outcomes. The candidate’s job is to compute the ratio, then interpret it within the accounts and the comparison being made.
The CFA programme page provides the wider study context. For a related accounting judgement that affects the reported numerator, see when a warranty becomes an expense.
Sources
- Financial Analysis Techniques | CFA Institute · cfainstitute.org · Retrieved
- Analyzing Income Statements | CFA Institute · cfainstitute.org · Retrieved
