Final answer:
The common size percentage for sales or revenue in vertical analysis is always 100%. This method compares each line item as a percentage of total sales, which helps analysts understand the financial structure and the effects of pricing changes on revenue.
Step-by-step explanation:
In vertical analysis of financial statements, specifically the income statement, the common size percentage for sales or revenue is always 100%. This is because in vertical analysis, each line item on the income statement is presented as a percentage of total sales or revenue. For example, if your total revenue is $500,000 and your cost of goods sold is $300,000, then the common size percentage for the cost of goods sold would be ($300,000 / $500,000) x 100%, which equals 60%. The revenue, being the base figure, is always considered to be 100%, giving a clear insight into how each component contributes to the total.
Understanding this concept is crucial when building mental models to analyze and compare financial statements at any scale. If a company sees a percentage rise in the price (P) of products sold, and assuming the quantity (Q) sold falls by the same percentage, the total revenue (P x Q) will remain unchanged. This relationship helps in predicting the impact of changes in pricing strategies on revenue. Furthermore, reproducing numbers from percentages in financial figures enables analysts to visualize the proportionate contributions of various items, which is often showcased in graphical forms such as bar graphs, where the visual width represents the scale of contributions relative to total revenue.