Financial statements are most valuable when used to compare across time and across companies. Learn how to common-size an income statement to compare information.
- In 2016, Walmart reported revenues of 482 billion dollars and net income of 15 billion dollars. Is that good, bad, up, down? How did Walmart do for the year? - Well, first of all, generating over 15 billion dollars in net income, that's pretty good. I wish I could have had a year like that. But, it turns out, that financial statements are most valuable when used to compare across time and across companies. - We can look at results across time for the same company and across companies for the same time.
Here, we can see that Walmart's income from continuing operations were down in 2016 when compared to prior years. - But, note that total revenues were down as well. So, was net income down as a percentage of total revenues compared to prior years? The easiest way to answer that question is to common size the income statement. - You common size the income statement by dividing all numbers for each year by total revenues. The result for Walmart looks like this. - We can see that, compared to 2015, Walmart's gross margin was actually up as a percentage of revenues by two tenths of one percent.
However, that gain was quickly gone as we see that operating expenses increased as a percentage of revenues by almost one whole percent, which is a lot when you are talking about hundreds of billions of dollars of revenue. - Interest costs, about the same as a percentage. Taxes, down a little. The net result, net income down from 3.5% of total revenues to 3.1%. Why? SGNA, selling, general, and administrative expenses. - With just a little simple arithmetic, we can quickly see where the problem was for Walmart.
Now Walmart can know where to focus its attention. - Should they get caught up in the cost of their debt, that is, their interest expense? No, it was about the same as the percentage as last year. - Should they talk to the people in charge of computing their income taxes? No, as a percentage of revenues, tax expense was down. - Was it cost of sales? No, gross margin was actually up as a percentage of revenues. - The issue for Walmart was operating, selling, general, and administrative expenses. Things like rent, wages, and utilities, and insurance.
It looks like the basic expenses of running a business got away from Walmart. - Now they can begin to break down those everyday expenses into smaller details to determine which specific expense has got away from them and what their plan is to get back on track. - They can talk to the people in charge of rent, or wages, or utilities, and determine what happened, and, most importantly, what can be done differently in the future. - Financial statements don't often answer the questions of interest, but they do inform us as to who we might speak with to get answers to the questions raised through financial statement analysis.
- Always remember that financial statements are the result of people making and implementing decisions. If things get away from us, financial statement analysis helps to identify where the issues might be with regard to decision-making and implementation and who we might speak with to find out what happened. - Common sizing an income statement helps us to identify issues of concern within a business and to ask the right questions to the right people about what happened. - And all it took was dividing one number on the income statement by another, simple math.
You can do that.
Skill Level Beginner
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