There are a lot of different ways a small-business owner can assess the health of his or her business—some are more reliable than others. One of the best tools you can use is a Common Size Income Statement (CSIS). A CSIS presents your company’s income statement in percentages. Each line item is represented as a percentage of revenues, instead of actual dollar amounts.
Sounds simple, but it's invaluable in helping you gauge how your expenses relate to your revenues, and provides a common basis for comparison.
Let's Do Some Math
The best way to see the value of the CSIS is to give you an example. Let’s assume that the following simplified Income Statement is representative of the fictional MyCo Inc.’s performance for a given year:
INCOME STATEMENT, MYCO, INC.
Cost of Goods Sold: $600,000
Wages Expense: $210,000
Advertising Expense: $122,000
Rent Expense: $24,000
Interest Expense: $15,000
Phone Expense: $12,000
Total Expenses: $1,001,000
Pre-tax income: $249,000
While the company is profitable, it’s difficult to deduce many other conclusions from just this information.
Now, let's prepare a CSIS using this information. First, I add a column to the right of the Income Statement and divide each line item by the amount of Revenues, which in this case are composed of $1,250,000 in sales. For example, for Cost of Goods Sold, I divide $600,000 by $1,250,000 = 48 percent. I then repeat this process until arriving at Pre-tax income. The final result is this:
COMMON SIZE INCOME STATEMENT MYCO, INC.
Sales: $1,250,000 = 100%
Cost of Goods Sold: $600,000 = 48%
Wages Expense: $210,000 = 17%
Advertising Expense: $122,000 = 10%
Rent Expense: $24,000 = 2%
Interest Expense: $18,000 = 1%
Supplies Expense: $15,000 = 1%
Phone Expense: $12,000 = 1%
Total Expenses: $1,001,000 = 80%
Pre-tax income: $249,000 = 20%
Using the CSIS, I now have a better idea of how each expense relates to my sales. MyCo is a COGS heavy business. My best bet for improving margins is to work on my COGS. A 10 percent improvement in COGS would improve profits more than eliminating my interest expense, supplies expense and phone expense entirely.
After a year, I now have a second CSIS to compare to the one above:
COMMON SIZE INCOME STATEMENT FOR ANALYSIS
Year 1 Revenue
Sales: $1,250,000 = 100%
Year 2 Revenue
Sales: $1,500,000 = 100%
Year 1 Expenses / Year 2 Expenses
Cost of Goods Sold: $600,000 = 48% / $660,000 = 44%
Wages Expense: $210,000 = 17% / $210,000 = 14%
Advertising Expense: $122,000 = 10% / $260,000 = 17%
Rent Expense: $24,000 = 2% / $24,000 = 2%
Interest Expense: $18,000 = 1% / $18,000 = 1%
Supplies Expense: $15,000 = 1% / $15,000 = 1%
Phone Expense: $12,000 = 1% / $12,000 = 1%
Total Expenses: $1,001,000 = 80% / $1,001,000 = 80%
Pre-tax income: $249,000 = 20% / $301,000 = 20%
This is where we can really begin to take advantage of a CSIS. If I just focus on sales and income, clearly the situation has improved; yet comparing the CSIS from one year to another reveals some additional insights:
- My COGS increased with the additional sales but my business was more efficient since COGS is now just 44 percent of sales instead of 48 percent.
- One area of concern is advertising expense. It jumped, representing 17 percent of sales versus 10 percent. Even though I was able to control my COGS, it came at the expense of advertising.
Armed with this insight, I know where to focus my efforts. For Year 3, I have to focus on keeping my advertising costs under control. If I can do this and keep everything else more or less in line, then it’s going to be a very profitable year.
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