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1997 1998 1998
Net Sales 100.0% 100.0% 100.0%
Costs excluding depreciation 87.6 87.2 87.6
Depreciation 3.2 3.3 2.8
Total Operating Costs 90.8 90.5 90.4
Earnings before interest & taxes 9.2 9.5 9.6
Less interest 2.1 2.9 1.3
Earnings before taxes 7.1 6.5 8.3
Taxes (40%) 2.8 2.6 3.3
Net income before preferred dividends 4.3 3.9 5.0
Preferred dividends 0.1 0.1 0.0
Net income available to common stockholders 4.1 3.8 5.0
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Consider the following, which is the 3-year income statement presentation for
Plantronics, Inc. included in their 10K statement filed June 5, 2006.
In the example of a vertical common size statement we discovered that cost of goods sold
rose to 56.5 percent of sales in fiscal year 2006 from 48.5 percent in 2005. Now consider
the same income statement expressed in the horizontal common size format. In this case,
2004 is used as the base year for each of the subsequent years.
Presented in this format, it is easy to see that a significant increase in the cost of sales
relative to total sales drove declining profit margins.
How can an investor fairly compare one company’s earnings to another, given that they
cannot be exactly alike in all other respects? How can the firm’s performance be
compared to its past performance to determine whether it is improving? Common size
analysis is one tool that allows investors to compare companies across time and with
other companies.
The following articles explain how to use common size analysis in practice:
1. Vertical Common Size Income Statements shows how to express the income
statement as a percentage of sales and use this data to analyze a company’s
performance over time.
2. Horizontal Common Size Income Statements demonstrates how to express the
financial statements in each year as a percentage of a given base year. This
permits an investor to see if certain expenses, assets or liabilities are growing
faster than others.
3. Common Size Balance Sheets can be used to compare companies even when they
use different currencies.
4. Using Common Size Statements to Forecast Earnings shows how to do just that.
In this format, the same data can be inferred because we see that sales grew 80 percent
from 2004 through 2006 while cost of sales grew 111 percent. (In each case taking the
ending value and subtracting the 100 percent starting value.) Since cost of sales are rising
much faster than sales themselves, it is clear that profitability is falling.
Consider our vertical common size income statement for Plantronics, Inc.
Right away we can see that research and development expense has remained fairly stable
between 8.1 and 8.5 percent. This suggests that Plantronics views them at least partially
as a variable cost. Higher revenues would result in higher expense, and the company
might trim the expense if sales decline. An earnings model might assume that R&D for
Plantronics would be 8.3 percent of sales, and the resulting estimate would probably be
close to the actual figure.
When making this type of estimate, it helps to look into the footnotes to see if there will
be any unusual expenses or changes to the historic relationship. An example of this can
be found on Stock Market Beat, in a post titled Plantronics Valuation. Plantronics plans
to increase both its advertising expense and its capital expenditures (future fixed costs) in
2007. Given this data, we will go with an estimate that SGA will grow 75 percent as fast
as sales.
The same method can be used to evaluate cost of sales. Again looking at the footnotes we
see that cost of sales is rising due both to increased capital expenditures and to a shift to
more consumer products at lower margins. This shift may continue since the recent
acquisition added new consumer lines, which might bring cost of sales up to 60 percent
of revenues from the current 56.5 percent.
http://www.brighthub.com/office/finance/articles/79118.aspx