======common-size_income_statement======
A common-size income statement (also known as '[[vertical analysis]]') is a financial tool that puts every company on a level playing field, regardless of its size. Think of it as a special lens for viewing a company's performance. Instead of showing dollar, euro, or pound amounts, it presents every single line item on an [[income statement]] as a percentage of total [[revenue]]. This simple trick instantly makes vast, complex numbers digestible. It strips away the intimidating scale of a multi-billion dollar corporation and allows you to compare its operational efficiency directly with a much smaller competitor. For a value investor, this isn't just an accounting exercise; it's a powerful way to understand the fundamental economics of a business and how well management is controlling costs and generating profits from every dollar of sales.
===== Why Bother with a Common-Size Income Statement? =====
The beauty of the common-size statement lies in its ability to reveal two critical things: trends within a single company over time and a fair comparison between different companies.
==== Spotting Trends Over Time ====
Looking at raw numbers can be misleading. A company's revenue might be growing, which seems great, but what if its costs are growing even faster? A common-size income statement cuts through this noise. By comparing statements from the last five or ten years, you can instantly see if the company's profitability is improving or eroding.
For example, is the percentage of revenue eaten up by the [[Cost of Goods Sold (COGS)]] creeping up year after year? This could signal that the company is losing its [[pricing power]] or facing rising input costs it can't pass on to customers. Are marketing expenses as a percentage of sales shrinking? That could mean its brand is getting stronger and more efficient at attracting customers. These trends are the bread and butter of fundamental analysis.
==== Comparing Apples to Apples (Company vs. Company) ====
Trying to compare General Motors with Tesla using their standard income statements is a headache. Their revenues are in different leagues. However, by using a common-size statement, you can ask much smarter questions:
  * Which company keeps a larger percentage of each sale after paying for the raw materials (i.e., has a better [[Gross Margin]])?
  * Which company spends a smaller percentage of its revenue on administrative overhead?
  * Which company is more effective at turning revenue into actual [[Net Income]]?
This analysis allows you to benchmark a company not only against its direct competitors but also against the industry average, providing crucial context for its performance.
===== How to Create and Read a Common-Size Income Statement =====
You don't need to be a math whiz to do this. Most financial data providers offer a 'common-size' view with the click of a button. But understanding how it's built is key to using it wisely.
==== The Simple Formula ====
Every line item is simply divided by the company's total revenue for that period and then multiplied by 100 to get a percentage.
  * **Formula:** (Specific Line Item / Total Revenue) x 100 = Percentage %
So, Revenue itself is always the 100% baseline. If a company has $10 million in revenue and its Net Income is $1.5 million, its [[Net Profit Margin]] is 15% ($1.5M / $10M x 100).
==== What to Look For: Red Flags and Green Lights ====
When you scan a common-size income statement, certain numbers should jump out at you.
  * **Green Lights (Positive Signs):**
    - **High and Stable (or Rising) [[Gross Profit]] Margin:** This is often the sign of a strong business with a durable [[competitive advantage]], or 'moat'. It shows the company has control over its production costs and can command a good price for its products.
    - **Stable or Decreasing [[Selling, General & Administrative (SG&A) expenses]]:** As a company grows, it should benefit from economies of scale. If its administrative costs are growing slower than its revenue, it's a sign of good management and operational efficiency.
    - **A Healthy Net Profit Margin:** This is the bottom line. A consistently strong net margin shows the business is profitable after //all// expenses are paid.
  * **Red Flags (Warning Signs):**
    - **Shrinking Gross Margin:** This is a major warning. It suggests increasing competition, a loss of pricing power, or an inability to control production costs.
    - **Bloating SG&A:** If administrative or marketing costs are rising as a percentage of sales, it could indicate inefficiency, wasteful spending, or a desperate attempt to buy growth.
    - **A Big Gap Between Gross and Net Margins:** If the Gross Margin is high but the Net Margin is tiny, it means huge [[Operating Expenses]] are eating all the profits. You need to dig in and find out why.
===== A Value Investor's Perspective =====
For a value investor, the common-size income statement isn't just a collection of percentages; it's a story about the business's character. [[Warren Buffett]] seeks businesses with "durable competitive advantages," and a consistently high and stable gross margin is one of the clearest quantitative indicators of such a moat. It shows a business that isn't just a commodity producer but one that offers something special that customers are willing to pay a premium for.
This tool is a starting point, not an endpoint. It helps you ask the right questions. Why did R&D spending as a percentage of sales suddenly drop? Is the company sacrificing its future for short-term profits? Why is one company's net margin double that of its closest competitor? Answering these questions requires you to go deeper into the other [[financial statements]], like the [[balance sheet]] and [[cash flow statement]], and to read the company's annual report. The common-size income statement is your map; it shows you exactly where to start digging for treasure.