Sunflower Intelligence
Finance & Accounting

F03 · Intermediate

Financial Statement Analysis

10 lessons

F03 · Module 1, lesson 2 · Lesson 2 of 10

Common-size statements

Express every line of the income statement as a share of revenue and every line of the balance sheet as a share of total assets, read the margins that result, and compare a small business with one thousands of times its size without being misled by how each one classifies its costs.

About 75 minutes

Before you start

You will be able to

  • Prepare a common-size income statement (as a percentage of net revenue) and a common-size balance sheet (as a percentage of total assets).
  • Calculate and interpret the gross, operating, EBITDA and net margins.
  • Explain how the classification of a cost (cost of sales or operating expense) and the accounting for leases move margins, and restate two businesses on the same basis.
  • Compare a small business with a much larger one using common-size figures, and state what common-size analysis cannot show.

Review first

  • Horizontal analysis — You compared Lantern’s two years line by line; this lesson compares the lines within each year.
  • The multi-step income statement — The multi-step income statement’s subtotals (gross profit, operating income) are the margins’ numerators.
  • The balance sheet and equity — Total assets, the base of the common-size balance sheet, and the classification of its lines come from there.

Fictional case A fictional coffee business founded by Ana Lim. It starts as a catering and barista-training service, opens its own cafés and an online shop for beans, and plans a canned cold brew.

The idea

Fictional case

Coastline Bank’s credit analyst has Lantern’s comparative statements and the horizontal analysis. She knows revenue nearly tripled and operating income fell. Her next question is about structure: out of each dollar Lantern took in, how much went on coffee and food, how much on staff and rent, and how much was left? And does that look like a coffee business that can carry debt? Answering it means putting 2026 ($193,320 of revenue in ten months) and 2027 ($577,860) on the same scale, and later putting Lantern beside companies far larger than itself.

Vertical analysis expresses each line of a statement as a percentage of a base figure in the same statement and the same period. A statement with every line shown that way is a common-size statement. On the income statement the base is net revenue (net sales), so each line reads as cents per dollar of revenue. On the balance sheet the base is total assets, which equals total liabilities and equity, so each line reads as a share of everything the business controls, or of how it is financed.

Dividing by a total removes size. Lantern’s 2026 and 2027 income statements differ by a factor of three, and Starbucks’ revenue is tens of thousands of times Lantern’s, yet on a common-size statement all three add to 100%. Vertical and horizontal analysis are partners: horizontal analysis says how fast a line grew; vertical analysis says whether it grew faster than the business around it. In 2027, 38.8% of each dollar of Lantern’s revenue went on cost of sales, 55.5% on operating expenses, and 5.7% was left as operating income; net income was 3.9%.

Lantern’s common-size income statement (% of net revenue; fictional)
Line2026 (%)2027 (%)Change (points)
Catering revenue32.220.5−11.8
Training revenue10.96.2−4.6
Online Sales revenue57.432.8−24.7
Café Sales revenue0.040.8+40.8
Sales returns and allowances−0.5−0.3+0.2
Net revenue100.0100.00.0
Cost of goods sold27.328.2+0.9
Cost of services18.710.6−8.1
Gross profit54.061.2+7.2
Wages expense9.527.9+18.4
Rent expense6.22.5−3.7
Utilities expense1.52.0+0.5
Advertising expense3.42.0−1.4
Insurance expense0.80.6−0.2
Depreciation expense2.53.4+0.9
Fuel expense1.00.5−0.5
Shipping expense6.53.5−3.0
Card and platform fees expense2.12.0−0.1
Bad Debt expense0.70.2−0.5
Miscellaneous expense0.30.3−0.0
Operating lease cost0.06.9+6.9
Market Research expense0.03.6+3.6
Operating income19.55.7−13.8
Interest expense0.60.5−0.1
Income before income tax18.95.2−13.7
Income Tax expense4.71.3−3.4
Net income14.23.9−10.3

Fictional figures from the case. Each line is divided by that year’s net revenue; expenses as positive shares; sales returns (contra-revenue) as a negative share of net revenue. 2026 covers ten months, but both the line and the base cover the same months, so no annualising is needed. Rounded to one decimal place, so columns may not add exactly.

In depth

Building a common-size statement

Divide every line by the base and keep the signs: expenses are shares of revenue, so cost of goods sold of 28.2% means 28.2 cents of each revenue dollar. Use net revenue, after returns and discounts, as the base, so that the subtotals read directly as margins. Use the same base for every line in a column, and show the change between years in percentage points. Because a common-size line is a ratio of two amounts from the same period, it needs no annualising: Lantern’s ten-month 2026 can be compared with 2027 directly, though seasonal months with an unusual mix of sales still colour a part-year.

The standard bases are conventions, and an analyst may choose a narrower one when it matches the question. A cost that belongs to one activity is better divided by that activity’s revenue: Lantern’s café staff as a share of café sales, not of all revenue, tells Ana whether the cafés are staffed sensibly. The same applies to a segment of a large company, or to a balance sheet line set against current assets rather than total assets. Say which base you used; a percentage without its base cannot be checked or compared.

The four margins

Four subtotals of the multi-step income statement, divided by net revenue, give the margins analysts quote most. The gross margin (gross profit ÷ net revenue) shows what is left after the direct cost of what was sold; it reflects pricing and the cost of goods. The operating margin (operating income ÷ net revenue) shows what is left after running the business; since Lantern has no other income, its operating income is its EBIT. The EBITDA margin adds depreciation and amortisation back, so it is not affected by how long ago assets were bought or how they are depreciated. The net margin (net income ÷ net revenue) is what the owners keep after interest and tax.

Margins: Lantern, Harbourline Roasters and Starbucks
MarginLantern 2026Lantern 2027HarbourlineStarbucks FY2024
Gross margin54.0%61.2%n/an/a
EBITDA margin22.0%9.1%14.5%19.4%
Operating margin19.5%5.7%9.5%15.0%
Net margin14.2%3.9%5.9%10.4%

Lantern and Harbourline Roasters Inc. are fictional (Harbourline’s figures are F00’s, in $ millions; it reports operating costs as one line, so it shows no gross profit). Starbucks: Form 10-K for fiscal 2024; operating income includes $301.2 million of income from equity investees; EBITDA adds the cash-flow statement’s depreciation and amortization ($1,592.4 million, total D&A) rather than the income-statement line ($1,512.6 million), which excludes D&A recorded within other cost lines; net margin uses net earnings attributable to Starbucks. Starbucks presents no gross profit (see below).

Read the margins as a cascade. Lantern kept 61.2% of revenue after the direct cost of sales in 2027, but operating expenses took 55.5%, leaving 5.7%; interest took 0.5% and tax 1.3%, leaving a net margin of 3.9%. A margin that falls between two subtotals locates the problem: in 2027 the damage was done between gross profit and operating income.

Classification moves margins

A margin depends on which lines sit above it. Lantern records the wages of its event baristas ($41,600 in 2027) in cost of services, because they are hired for each catering job; the café staff ($92,000) are in wages expense, an operating expense, because they work fixed shifts whatever the day’s takings. Both choices are defensible. Had Lantern put the café staff in cost of sales, its 2027 gross margin would have been 45.3% instead of 61.2%, below 2026’s 54.0%, and the story “gross margin improved” would have disappeared. The operating margin would not change at all: moving a cost between two lines above operating income changes the subtotal between them, not the operating income.

Companies choose their own expense captions, and two businesses in the same industry can put the same cost on different lines. Starbucks does not present cost of sales or gross profit at all. Its statement of earnings lists product and distribution costs (30.9% of total net revenues in fiscal 2024), store operating expenses (42.3%), other operating expenses, depreciation and amortization, and general and administrative expenses as separate operating expenses. Subtracting only product and distribution costs from revenue would give 69.1%, a figure Starbucks does not report and that is not comparable with a retailer’s gross margin that includes store costs. When two companies classify differently, compare the margins below the point where their classifications converge (operating or EBITDA margin), or rebuild both on one definition from the notes.

The common-size balance sheet

On the balance sheet the base is total assets. The common-size view shows how the business has deployed its resources and how it has financed them, independent of size. Lantern’s balance sheet changed character in 2027: cash fell from 45.8% of total assets to 2.0%, the cafés’ right-of-use assets became 52.9% of the total, and equity, which financed 45.2% of the assets at the end of 2026, financed only 19.2% a year later.

Lantern’s common-size balance sheet, condensed (% of total assets; fictional)
Line at 31 December2026 (%)2027 (%)Change (points)
Cash45.82.0−43.8
Accounts receivable, net7.33.3−4.0
Contract asset0.09.4+9.4
Inventory, supplies and prepaid insurance7.23.4−3.8
Total current assets60.318.0−42.3
Property and equipment, net39.729.1−10.6
Operating lease right-of-use assets0.052.9+52.9
Total assets100.0100.00.0
Total current liabilities28.134.9+6.9
Operating lease liabilities (current and noncurrent)0.052.9+52.9
Debt (notes, instalment note, line of credit)32.019.9−12.1
Total liabilities54.880.8+26.1
Total equity45.219.2−26.1

Fictional figures from the case. Total liabilities plus total equity equal total assets (100%) in each year.

A falling share is not always a falling amount. Lantern’s property and equipment grew from $37,200 to $95,400, yet its share of total assets fell from 39.7% to 29.1%, because the right-of-use assets grew faster still. Read the common-size percentages beside the dollar amounts and the horizontal changes, never instead of them.

Comparing with a much larger business

Common-size statements make comparisons across scale possible. Harbourline Roasters, F00’s fictional listed roaster, has revenue of $640 million, about 1,108 times Lantern’s; Starbucks’ fiscal 2024 revenue of $36,176.2 million is about 62,604 times. On the margins table, Lantern’s 2026 margins beat both, before Ana was paid a salary, while its 2027 operating margin of 5.7% is below Harbourline’s 9.5% and well below Starbucks’ 15.0%.

The balance sheets differ more. Harbourline’s equity finances 45.5% of its assets and its debt 31.8%; Lantern’s equity finances 19.2%, with lease liabilities at 52.9% and other debt at 19.9%. Starbucks’ total liabilities are 123.7% of its total assets, so its shareholders’ equity is a deficit of 23.7% of assets; its operating lease liabilities are 32.7% and its right-of-use assets 29.6%. A negative equity line is a warning that some ratios built on equity will mean nothing, a point the solvency and returns lessons take up.

What common-size statements cannot show

  • Scale. A 3.9% net margin on $577,860 is $22,431: enough for one owner-manager, not for a business that must also repay $65,250 of debt. Dollars still matter, and so does size: a large chain buys coffee and leases premises on terms a two-café business cannot get.
  • Cash and timing. Margins are accrual measures. Lantern’s 2027 revenue includes the law firm’s contract revenue that will not be billed until March 2028; the cash-flow lessons ask how much of the margin arrived as cash.
  • Growth. Each percentage is one year’s structure. A share can fall while the amount rises, as Lantern’s property and equipment did; pair vertical with horizontal analysis.
  • Whether a percentage is good. A 27.9% wage share means little without a benchmark for comparable cafés and caterers, which the benchmarking lesson discusses.
  • Causes. A percentage that changes because its base changed (revenue fell, or a large asset was added) can look like a change in the line itself.

Formulas

Common-size income statement line

Line, % of revenue=Line amountNet revenue×100\text{Line, \% of revenue} = \dfrac{\text{Line amount}}{\text{Net revenue}} \times 100
Line amount\text{Line amount}
Any line of the income statement for the period (revenue, cost, subtotal)$
Net revenue\text{Net revenue}
Revenue after returns, allowances and discounts, for the same period$

Lantern’s 2027 cost of goods sold: 163,125÷577,860=28.2%163{,}125 \div 577{,}860 = 28.2\%.

Common-size balance sheet line

Line, % of total assets=Line amountTotal assets×100\text{Line, \% of total assets} = \dfrac{\text{Line amount}}{\text{Total assets}} \times 100
Line amount\text{Line amount}
Any asset, liability or equity line at the balance sheet date$
Total assets\text{Total assets}
Total assets at the same date (equal to total liabilities and equity)$

Lantern’s right-of-use assets at 31 December 2027: 173,379÷327,883=52.9%173{,}379 \div 327{,}883 = 52.9\%.

Gross margin

Gross margin=Net revenue−Cost of salesNet revenue\text{Gross margin} = \dfrac{\text{Net revenue} - \text{Cost of sales}}{\text{Net revenue}}
Net revenue\text{Net revenue}
Revenue after returns, allowances and discounts$
Cost of sales\text{Cost of sales}
Cost of goods sold plus cost of services, as the business classifies them$

Assumes. Depends on what the business puts in cost of sales; compare only like definitions.

Lantern 2027: (577,860−224,205)÷577,860=61.2%(577{,}860 - 224{,}205) \div 577{,}860 = 61.2\%.

Operating margin

Operating margin=Operating incomeNet revenue\text{Operating margin} = \dfrac{\text{Operating income}}{\text{Net revenue}}
Operating income\text{Operating income}
Gross profit less operating expenses (EBIT when there is no other income or expense)$
Net revenue\text{Net revenue}
Revenue after returns, allowances and discounts$

Lantern 2027: 32,787÷577,860=5.7%32{,}787 \div 577{,}860 = 5.7\%.

EBITDA margin

EBITDA margin=EBIT+D&ANet revenue\text{EBITDA margin} = \dfrac{\text{EBIT} + \text{D\&A}}{\text{Net revenue}}
EBIT\text{EBIT}
Earnings before interest and taxes; for Lantern, operating income$
D&A\text{D\&A}
Depreciation and amortisation for the period (all of it, wherever it is presented)$
Net revenue\text{Net revenue}
Revenue after returns, allowances and discounts$

Assumes. A non-GAAP measure: under US GAAP operating lease cost stays inside EBITDA; under IFRS 16 it does not.

Lantern 2027: (32,787+19,800)÷577,860=9.1%(32{,}787 + 19{,}800) \div 577{,}860 = 9.1\%.

Net margin

Net margin=Net incomeNet revenue\text{Net margin} = \dfrac{\text{Net income}}{\text{Net revenue}}
Net income\text{Net income}
Net income for the period (attributable to the parent’s owners when there are noncontrolling interests)$
Net revenue\text{Net revenue}
Revenue after returns, allowances and discounts$

Lantern 2027: 22,431÷577,860=3.9%22{,}431 \div 577{,}860 = 3.9\%. Also called the net profit margin or return on sales.

Worked examples

A first example: A clothing brand’s margins

Fictional figures

Larch & Loom, a fictional clothing brand, reports for 2027: net revenue $4,800,000; cost of goods sold $2,160,000; selling, general and administrative expenses $1,920,000; depreciation and amortisation $240,000; interest expense $96,000; income tax at 25% of income before tax. Prepare its common-size income statement and its four margins.

Larch & Loom: common-size income statement for 2027 (fictional)
LineAmount ($)% of net revenue
Net revenue4,800,000100.0
Cost of goods sold(2,160,000)45.0
Gross profit2,640,00055.0
Selling, general and administrative expenses(1,920,000)40.0
Depreciation and amortisation(240,000)5.0
Operating income480,00010.0
Interest expense(96,000)2.0
Income before income tax384,0008.0
Income tax expense(96,000)2.0
Net income288,0006.0
  1. Gross profit: 4,800,000−2,160,000=2,640,0004{,}800{,}000 - 2{,}160{,}000 = 2{,}640{,}000; gross margin 2,640,000÷4,800,000=55.0%2{,}640{,}000 \div 4{,}800{,}000 = 55.0\%. Cost of goods sold is 45.0%45.0\%.
  2. Operating income: 2,640,000−1,920,000−240,000=480,0002{,}640{,}000 - 1{,}920{,}000 - 240{,}000 = 480{,}000; operating margin 10.0%10.0\%. Selling, general and administrative expenses are 40.0%40.0\% and D&A 5.0%5.0\%.
  3. EBITDA: 480,000+240,000=720,000480{,}000 + 240{,}000 = 720{,}000; EBITDA margin 15.0%15.0\%.
  4. Income before tax: 480,000−96,000=384,000480{,}000 - 96{,}000 = 384{,}000 (8.0%8.0\%); tax 96,00096{,}000 (2.0%2.0\%); net income 288,000288{,}000, a net margin of 6.0%6.0\%.

Answer. Cost of goods sold 45.0%, gross margin 55.0%; SG&A 40.0%, D&A 5.0%, operating margin 10.0%; EBITDA margin 15.0%; interest 2.0%, income before tax 8.0%, tax 2.0%, net margin 6.0%.

What it means. Of each dollar of sales, 45 cents buys the clothes, 40 cents runs the brand and 6 cents reaches the owners. Selling and administration, not the product cost, is the line to watch: a fall in its share is the fastest route to a better operating margin.

A harder example: Two bakery chains, two classifications

Fictional figures

Two fictional bakery-café chains report for 2027. Copperleaf Bakeries: revenue $12,000,000; cost of sales $6,600,000, which includes $3,000,000 of store staff wages; operating expenses $4,200,000. Juniper Street Bakery: revenue $3,000,000; cost of sales (ingredients and packaging) $960,000; store staff wages $840,000 and other operating expenses $870,000, both in operating expenses. A lender says Juniper is “the better business: a 68% gross margin against 45%”. Is it?

Gross margin on each definition (fictional)
DefinitionCopperleafJuniper Street
As reported45.0%68.0%
Store staff in cost of sales45.0%40.0%
Store staff in operating expenses70.0%68.0%
Operating margin (unaffected)10.0%11.0%
  1. As reported: Copperleaf gross margin (12,000,000−6,600,000)÷12,000,000=45.0%(12{,}000{,}000 - 6{,}600{,}000) \div 12{,}000{,}000 = 45.0\%, operating margin 1,200,000÷12,000,000=10.0%1{,}200{,}000 \div 12{,}000{,}000 = 10.0\%. Juniper gross margin (3,000,000−960,000)÷3,000,000=68.0%(3{,}000{,}000 - 960{,}000) \div 3{,}000{,}000 = 68.0\%, operating margin 330,000÷3,000,000=11.0%330{,}000 \div 3{,}000{,}000 = 11.0\%.
  2. Restate Juniper with store staff in cost of sales, as Copperleaf does: cost of sales 960,000+840,000=1,800,000960{,}000 + 840{,}000 = 1{,}800{,}000; gross margin 1,200,000÷3,000,000=40.0%1{,}200{,}000 \div 3{,}000{,}000 = 40.0\%, below Copperleaf’s 45.0%.
  3. Or restate Copperleaf with staff out of cost of sales: 6,600,000−3,000,000=3,600,0006{,}600{,}000 - 3{,}000{,}000 = 3{,}600{,}000; gross margin 70.0%70.0\%, above Juniper’s 68.0%. On either common definition Copperleaf’s gross margin is higher.
  4. The operating margins need no restatement: staff are above operating income in both. Juniper’s 11.0% beats Copperleaf’s 10.0% because its other costs are a smaller share: Copperleaf’s operating expenses are 35.0%35.0\% of revenue; Juniper’s other operating expenses are 29.0%29.0\%.

Answer. No. The 23-point gap in reported gross margin is classification. On a common definition Copperleaf’s gross margin is higher (45.0% against 40.0%, or 70.0% against 68.0%), while Juniper’s operating margin is higher, 11.0% against 10.0%, because of lower overheads.

What it means. Compare margins only on the same definition. The operating margin, below the point where the two classifications meet, is the fair comparison here; Juniper’s advantage is in its overheads, not its baking. Common-size statements also hide that Copperleaf is four times Juniper’s size.

Applied: a business decision: Lantern beside Harbourline: what should Coastline ask?

Fictional figures

Coastline’s analyst compares Lantern’s 2027 common-size statements with Harbourline Roasters’, a much larger fictional roaster, before Lantern asks to increase its line of credit. Use the margins table and the common-size balance sheets above.

  1. Margins: Lantern’s EBITDA margin is 9.1% against Harbourline’s 14.5%; its operating margin 5.7% against 9.5%; its net margin 3.9% against 5.9%. Lantern earns less on each dollar at every level.
  2. Lantern’s EBITDA includes the café lease cost (6.9% of revenue), and it also bears a cost that should not recur: research was 3.6% of revenue. Without the research, Lantern’s operating margin would have been (32,787+21,000)÷577,860=9.3%(32{,}787 + 21{,}000) \div 577{,}860 = 9.3\%, close to Harbourline’s.
  3. Financing: equity finances 19.2% of Lantern’s assets and 45.5% of Harbourline’s. Lantern’s lease liabilities alone are 52.9% of its assets.
  4. Liquidity in outline: cash is 2.0% of Lantern’s assets and 6.8% of Harbourline’s; Lantern’s current liabilities are 34.9% of its assets against 18.0% in current assets.

Answer. Lantern’s margins are thinner than Harbourline’s at every level (operating 5.7% against 9.5%), mostly because of the research programme and the cafés’ first-year costs, and its balance sheet is financed far more by liabilities (equity 19.2% of assets against 45.5%). The analyst should ask whether the research recurs, how the cafés’ wage and lease shares are trending month by month, and how Lantern will rebuild cash before lending more.

What it means. Common-size statements tell the analyst where Lantern differs from a peer and therefore what to ask; they do not tell her whether to lend. That needs the liquidity, solvency and cash-flow measures of the next modules, and the knowledge that Harbourline, many times Lantern’s size, is not the perfect benchmark either.

Explore

Lantern’s margins beside Harbourline’s and Starbucks’. Tick “Annualise part-year flows” and notice that no margin moves. Then tick the reclassification of café staff and watch the gross margin fall while the operating margin stays where it was.

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Where each dollar of revenue went, 2026 against 2027. Compare the wage and occupancy bars with the operating income bar.

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Lantern’s balance sheet at 31 December 2027. Type a formula in C2 that divides cash by total assets, fill it down, and check your column against the common-size table. Then try the 2026 figures from the comparative balance sheet in column B.

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Common mistakes

  • “Juniper’s 68% gross margin beats Copperleaf’s 45%.”

    Gross margins depend on what each business puts in cost of sales. Restate both on one definition, or compare a margin below the point where the classifications meet, such as the operating margin. Starbucks presents no gross profit at all.

  • “Lantern’s 2026 margins must be annualised first.”

    A margin divides one flow by another for the same months, so the period length cancels out. Annualise flows for horizontal comparisons, not for margins. (Seasonality can still make a part-year’s mix unusual.)

  • “Property’s share fell, so Lantern has less equipment.”

    A common-size share can fall because the total grew faster. Lantern’s property and equipment rose from $37,200 to $95,400 while its share fell from 39.7% to 29.1%. Read the dollars and the horizontal change beside the percentage.

  • “A common-size balance sheet uses revenue as its base.”

    The balance sheet’s base is total assets (equal to total liabilities and equity), both measured at the same date. Revenue is a flow over a period and is the base for the income statement only.

  • “EBITDA margins are comparable everywhere.”

    EBITDA is not defined by US GAAP, and lease accounting differs: under ASC 842 operating lease cost stays inside EBITDA, while under IFRS 16 it is replaced by depreciation and interest, which EBITDA excludes. Adjust before comparing a US GAAP reporter with an IFRS one.

Guided practice

Work through these with hints when you need them. Every hint and every worked solution is there to be used.

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On your own

No hints this time. Answer, check, and read the feedback; the solution appears once you have answered or if you ask for it. Your first answers count toward mastery.

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In practice

The lender’s structure check. Coastline’s analyst keeps a page of common-size statements for every small-business borrower in food and drink. Lantern’s 2027 page shows wages at 27.9% of revenue and occupancy (kitchen rent and café leases) at 9.4%, against 9.5% and 6.2% in 2026. Those two lines explain most of the fall in the operating margin. Her credit memo states the margins, names the lines that moved and asks Lantern for the cafés’ monthly wage and lease shares, because a café business whose wages stay near a quarter of revenue in its second year needs higher prices or fewer staff hours to service more debt.

The owner’s targets. Ana uses the same percentages to set targets. If café staff can be scheduled to cost no more than a set share of café sales, she can check it every month from the till reports and the payroll without waiting for the year-end statements. She also learns to explain her margins in the bank’s terms: the gross margin rose because the cafés’ coffee costs little to make, but their staff and premises sit below gross profit, which is why she shows the operating margin first.

The investor’s screen. An equity analyst comparing Starbucks with other restaurant companies would not compare gross margins, because Starbucks presents none. She would compare operating margins and EBITDA margins, adjusting for leases where a peer reports under IFRS, and use the common-size balance sheet to spot what is unusual: a shareholders’ deficit and lease liabilities of about a third of total assets.

Knowledge check

Six questions, one attempt each, no hints. Score 80% or more to complete the lesson; you can take it again at any time.

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Summary

  • Vertical analysis divides each line by a base in the same statement: net revenue for the income statement, total assets for the balance sheet. The result, a common-size statement, removes scale.
  • The gross, operating, EBITDA and net margins are the income statement’s subtotals as a share of revenue; where a margin falls between two subtotals shows where the problem is. Lantern’s gross margin rose from 54.0% to 61.2% while its operating margin fell from 19.5% to 5.7%.
  • Margins need no annualising: both parts cover the same months.
  • Classification moves margins: Lantern’s café staff in operating expenses, its event baristas in cost of services, and Starbucks’ separate product, store and administrative lines. Compare like definitions, or the operating margin.
  • Lease accounting moves EBITDA: under ASC 842 operating lease cost is inside EBITDA, under IFRS 16 it is not.
  • Common-size statements make a two-café business comparable with Harbourline or Starbucks, but they hide scale, cash, growth and causes: read them with the dollars and the horizontal changes.

Key formulas

Terms introduced

Vertical analysis
Expressing each line of a financial statement as a percentage of a base in the same statement and period: net revenue for the income statement, total assets for the balance sheet.
Common-size statement
A financial statement in which every line is shown as a percentage of a base figure (net revenue or total assets), so that businesses of different sizes, or one business in different years, can be compared.
Operating margin
Operating income divided by net revenue: the share of each dollar of revenue left after the costs of running the business, before interest and income tax.
EBITDA margin
EBITDA (earnings before interest, taxes, depreciation and amortisation) divided by net revenue. A non-GAAP measure, affected by how leases are accounted for.
Net margin
Net income divided by net revenue: the share of each dollar of revenue the owners keep after all expenses, interest and tax. Also called the net profit margin.

Sources

  1. Dahlquist, J. & Knight, R. (2022). Principles of Finance, section 5.7, “Common-Size Statements”. OpenStax. openstax.org/books/principles-finance/pages/5-7-common-size-…
  2. Franklin, M., Graybeal, P. & Cooper, D. (2019). Principles of Accounting, Volume 1: Financial Accounting, Appendix A, “Financial Statement Analysis” (vertical analysis and its bases). OpenStax. openstax.org/books/principles-financial-accounting/pages/a-f…
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