So let's discuss another tool of financial analysis, the use of common size statements. What we're going to see is that common size statements report only percentage amounts. They're not going to show any dollar amounts. We're used to showing an income statement or a balance sheet in the form of dollar amounts, right? But instead, we are going to show them as percentages. This is exactly just the results of a vertical analysis. If you want more practice with common size statements, just use vertical analysis. Vertical analysis is the same exact thing. We're basically just showing the results of that vertical analysis. So, like we learned with vertical analysis, the income statement base, we're going to use a base for each of the statements. When we do the income statement, the income statement base is going to be sales revenue. Our sales revenue and on the balance sheet, we'll use either total assets or total liabilities and equity. Remember, these numbers are the same, right? Because assets equal liabilities and equity, so it's going to be the same number when we use the balance sheet. What we're going to do is find a percentage of that base item that's going to be each line item. So you'll imagine, we'll start with if it was an income statement, we'll show sales and show what percentage of our sales, sales is and it's going to be 100%. And then we'll show the cost of goods sold. What percentage of net sales is the cost of goods sold? We'll keep going down and show each thing as a percentage of net sales. On the balance sheet, it will be the same thing. We would have a certain amount of total assets and we would show how much of our total assets is cash as a percentage. When we use percentages, it makes it a lot easier to compare across companies because maybe companies are different sizes. When we show cash in one business of $1,000,000 it might seem like a significant difference, and it's going to make a difference, right? It's going to be able to be compared when it's percentages because if we have $1,000,000 as our cash out of $10,000,000 well 10% of our balance is in cash. Whereas, if we have $50,000 out of $500,000 well that's 10% of our balance in cash as well, right? So as a percentage, we can compare different size companies. That's the main benefit of common size statements. So, just like with vertical analysis, we're going to use this formula, percentage of the base, the line item amount divided by the base amount and the base amount is going to be defined up here depending on which statement we're doing, the income statement or the balance sheet. So let's go ahead and do an example. This is very similar to what we've already done with vertical analysis, so we're just going to reiterate what we learned there.

So let's calculate the common size percentages for each of this income statement. They gave us a pretty simple income statement here, let's go ahead and do our common size statement. So remember, our base is going to be net sales. So the bottom part of our fraction will always be 150,000. So for this one, it would be 150,000 divided by 150,000 and that gives us 100%. It's going to be 100% and that's always going to be like that for net sales because it's 100% of itself. Now, let's go on to the cost of goods sold. The cost of goods sold is 60,000 out of 150,000. So what does that come out to?60000150000, well, that's 40%. So this tells us that 40% of our sales go to the cost of goods sold. And that obviously means that the rest is going to be gross profit here, but let's calculate it.90000150000 and that should equal 0.6 and it does, right? 60% and that should make sense. If 40% of it is the cost of goods sold, well, the other 60% is our gross profit. So let's keep going here. Our operating expenses are 40,000 out of 150,000. So40000150000, it comes out to 26.6%. I'll round it to 26.7%, So 26.7% is going to be our operating expenses and let's keep going, 50,000 out of 150,000, well that should be the subtraction there. 60 minus the 26.7 will leave us with the 33.3% left for income from operations, right? So, one-third of our net sales is income from operations. That's pretty good information, right? Now we know that one-third of our net sales is income from operations. For every dollar that of sales we have, $0.33 is income from operations. Now, our taxes, 15,000 out of 150,000 well, that's 10% right there, 10% of our sales. And then finally, 35,000 is left as net income out of 150,000, so35150 gives us 23.3%. So our net income is 23.3 percent of our net sales, that's good information. Now this can help us compare amongst companies of different sizes when we just look at it from a percentage basis. Cool? This isn't too complicated at all, you just have to remember what your base is going to be. On the income statement, you always use net sales. On the balance sheet, you always use either total assets or total liabilities and equity. It's the same number. Cool? All right. Let's go ahead and move on to the next.