What you will learn
- Convert a line item into a percentage of revenue or total assets
- Explain how common-size statements make companies of any size comparable
- Tell the difference between vertical and horizontal analysis
- See how common-size analysis leads into the capstone teardown
Comparing a giant company to a small one using raw dollars is like comparing two photographs printed at different sizes. The proportions get lost. Common-size statements fix this by turning every line item into a percentage, so the structure and the trends jump out no matter how big or small the company is. And you have already used this idea without naming it, because the margins you calculated earlier are common-size income statement figures.
Common-size analysis of the income statement (TLC Tutoring)
A step-by-step demo of converting an income statement to percentages of revenue. Follow the arithmetic, then try the calculation below.
The simple idea
- On a common-size income statement, every line is shown as a percentage of revenue. Revenue itself is 100 percent, and you instantly see what share goes to COGS, operating expenses, taxes, and profit.
- On a common-size balance sheet, every line is shown as a percentage of total assets, revealing the proportional makeup of what the company owns and how it is financed.
Key terms
- Common-size statement
- A statement where each line is shown as a percentage of a base, so size no longer matters.
- Vertical analysis
- Looking at proportions within a single period, such as each cost as a share of revenue.
- Horizontal analysis
- Tracking how line items change across several periods to reveal trends.
Turning dollars into percentages strips away the distraction of size. A small company and a giant can now sit side by side, their cost structures and financing mixes directly comparable. All you need is division.
Building one common-size line
A company has revenue of 500,000 dollars and cost of goods sold of 300,000 dollars. Express COGS as a percentage of revenue.
- Set revenue as the base. Revenue of 500,000 is 100 percent.
- Divide COGS by revenue. 300,000 divided by 500,000 equals 0.60.
- Convert to a percent. 0.60 times 100 is 60 percent.
Why it matters: Once every line is a percent of revenue, you can compare this company's cost structure directly with a rival ten times its size.
Express a line as a percent of revenue
A company has revenue of 800,000 dollars and operating expenses of 200,000 dollars. On a common-size income statement, what percentage of revenue is operating expenses?
| Line | Dollars | Percent of revenue |
|---|---|---|
| Revenue | $500,000 | 100% |
| COGS | $300,000 | 60% |
| Gross profit | $200,000 | 40% |
| Operating expenses | $120,000 | 24% |
| Operating income | $80,000 | 16% |
Vertical and horizontal analysis
Common-size statements support two views that work together. Vertical analysis looks at proportions within a single period, meaning what share of revenue each cost consumes right now. Horizontal analysis tracks how those line items change over several periods, revealing trends, such as COGS slowly creeping up as a percentage of revenue and quietly eroding profitability. Together they turn a static snapshot into a moving picture.
Dollars tell you how big. Percentages tell you how the business is built, and which way it is drifting.
Common-size analysis of the balance sheet (TLC Tutoring)
Applies the same technique to the balance sheet, using total assets as the base. Watch to see how the financing mix becomes clear in percentages.
Spot the drift
Over five years, a company's revenue grew every year, but on its common-size income statement COGS rose from 55 percent to 65 percent of revenue. What does that tell you, and which type of analysis revealed it?
COGS rising from 55 to 65 percent of revenue means a shrinking gross margin. Tracking that percentage over several years is horizontal analysis.Why percentages beat dollars for comparison
Explain in a couple of sentences why common-size statements let you compare a small startup with a giant competitor, something raw dollar figures cannot do well.
Write an answer before comparing it with the model response.
Model answer
Raw dollars are dominated by size, so a giant's costs will always look bigger than a startup's even if the giant is far more efficient. Common-size statements convert every line to a percentage of revenue or assets, which removes the effect of size and lets you compare cost structures and financing mixes directly. Now a 60 percent COGS ratio can be compared fairly no matter how large each company is.
What it reveals and where it leads
Common-size analysis surfaces things raw numbers hide: a competitor with a structurally lower cost base, a company whose overhead is creeping up, a shift toward more debt financing year over year, or an improving gross margin that signals growing pricing power. It is one of the most accessible yet powerful diagnostic tools, and it needs nothing more than division. By converting a company's statements to percentages and comparing them against peers and its own history, you can quickly form ideas about its strengths, weaknesses, and direction, which you then confirm with the ratios and cash flow checks from this unit. That is exactly what the final lesson, the capstone teardown, pulls together.