Which of the following best explains why financial managers use a common-size income statement?

• A. To comply with international accounting standards for financial reporting.
• B. To eliminate the need for ratio analysis when evaluating company performance.
• C. To compare the relative proportions of each income statement item to total sales, making it easier to analyze companies of different sizes.
• D. To convert all income statement figures into cash flow amounts.

Answer: (C)

Verified step by step guidance

1. Understand the concept of a common-size income statement: A common-size income statement expresses each line item as a percentage of total sales or revenue. This allows for easier comparison between companies of different sizes or across different periods.
2. Identify the purpose of using a common-size income statement: Financial managers use it to analyze the relative proportions of income statement items, such as cost of goods sold, operating expenses, and net income, in relation to total sales.
3. Recognize the advantage of common-size income statements: By converting absolute figures into percentages, it becomes easier to compare companies of varying sizes or industries, as the scale of operations does not distort the analysis.
4. Eliminate incorrect options: Review the provided choices and rule out options that do not align with the purpose of a common-size income statement. For example, it is not used to comply with international accounting standards or to convert figures into cash flow amounts.
5. Select the correct explanation: The correct answer is that financial managers use a common-size income statement to compare the relative proportions of each income statement item to total sales, facilitating analysis across companies of different sizes.