- CFA Exams
- Level I 2020
- Study Session 7. Financial Reporting and Analysis (2)
- Reading 21. Understanding Income Statements
- Subject 8. Analysis of the Income Statement
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Subject 8. Analysis of the Income Statement PDF Download
Common-Size Analysis of the Income Statement
This topic will be discussed in detail in Reading 26 [Financial Analysis Techniques].
Income Statement Ratios
The following operating profitability ratios measure the rates of profit on sales (profit margins).
- Net Profit Margin shows how much profit is generated on every dollar of sales.
- Gross Profit Margin equals percent of sales available after deducting cost of goods sold.
- A declining gross profit may indicate increasing costs of production or declining prices.
- The ratio can be affected by changes in the company's product mix: a change toward items with higher (lower) margin raises (reduces) the gross profit margin.
- A small change in gross profit can result in a much larger change in profit margin if the company has high fixed costs.
Learning Outcome Statementsj. convert income statements to common-size income statements;
k. evaluate a company's financial performance using common-size income statements and financial ratios based on the income statement;
CFA® Level I Curriculum, 2020, Volume 3, Reading 21
User Contributed Comments 10
|kaleem||common size ratios are useful in analysing debt equity ratio|
|SaeedAlam||"A small change in gross profit can result in a much larger change in profit margin if the company has high fixed costs."
I can't figure this out...
|nayagan||Should "net profit" used in net profit margin include preferred dividends?|
|miliee84||I agree with Saeed. Can someone please explain what it means?|
|jpducros||Nayahan, the text above says the net income is earning after tax but before dividends, but they mean dividend paid. Concerning dividend received, be them preferred or not, I would think they are included. TBC...|
|moneyguy||@nayagan- I would say no. Preferred Div are only deducted from net income to calculate EPS.|
|CFAToad||Preferred dividends are subtracted from Net Income. Net income only includes income owed to common shareholders. I think of preferred dividends as a debt payment, as it is not optional.|
|CFAToad||For more clarity. refer back to g and h. When a convertible preferred share is exercised, the numerator increases by amount of the preferred dividends that would have been owed. So the numerator becomes NI- dividends + preferred dividends.|
|sshetty2||I agree with above comments I don't understand the last item about larger change in profit margin with high fixed costs. I think they mean more significant change in profit margin..|
|akhlo||For those that are confused about the last point re change in gross profit resulting in larger change in net profit margin: If revenue = 100, COGS = 50, G&A = 40, no tax, NI would be 10, hence net profit margin is 10% and gross profit margin is 50%. Say if gross profit margin decrease by 10% to 40% (meaning revenue minus COGS = 40), G&A stays the same, no tax, then NI will become 0. Gross profit margin decreased by 10% but net profit margin decreased by 100%. Hope this helps.|