Purpose of Income Statement

What is the Purpose of Income Statement?

The income statement is one of the important financial reports of the company. It is prepared with the purpose of providing the summary of all the revenues and the expenses over time to ascertain the profit or loss of the company. Also, it is used to measure business activity over time depending upon various requirements of users of an income statement.

The income statement is the statement of all expenses and income over time. When preparing the financial statements, every business starts with preparing the income statement for that period. The income statement forms an integral part of the books of accounts. In addition, it serves as an indicator for the business, which shows the company’s performance for the period ending every year or whenever the statement is prepared.

• The purpose of the income statement is to represent the company’s performance during a period to the investors and help value the company, which affects the share price.
• The income is used to summarize the company’s profitability by classification of revenue and The purpose is to provide a representation of the company’s performance during a period to the investors and the value of the company, which affects the share price.
• The income is used to summarize the company’s profitability by classification of revenue and expense accruedExpense AccruedAn accrued expense is the expenses which is incurred by the company over one accounting period but not paid in the same accounting period. In the books of accounts it is recorded in a way that the expense account is debited and the accrued expense account is credited.read more in the income statement during that period.

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For eg:
Source: Purpose of Income Statement (wallstreetmojo.com)

Purpose of Income Statement for Various Stakeholders

The purpose of income statement is to serve as a reporting tool for various stakeholders: –

#1 – The Management

source: Colgate SEC Filings

The most vital viewer of the income statement is the management. It gives the directors and the executive a very clear picture of the company’s performance during the period. The income statement of the period serves as an indicator of how the strategy which was planned by the management of the company at the beginning of the period has paid off and where is the scope of improvement

#2 – The Investor

If the company is a publicly-traded entity, then its annual report needs to be prepared and published annually before the books are closed. The most crucial purpose of the income statement is that it serves as a good source of analysis for investors willing to invest in the company. In addition, the income statement serves as a good source for a fundamental analysis of the company. The investor can analyze the income statement and can make an economic decision on whether they should invest in the company.

#3 – The Lender

Every quarter banks or financial institutions demand the income statement be submitted for the review and the utilization proceeds of it. After analyzing the income statement, the bank decides whether it should extend the limit enjoyed by the company or amend the sanction terms as per the company reporting numbers.

#4 – The Creditors

The company’s creditors, mainly short-term creditors like the suppliers and the subcontractor, have a close look at the numbers reported by the company. The income statement shows the company’s creditworthiness to repay its current obligation. It also serve as an indicator for the suppliers and the creditors to maintain the relationship and the credit terms with the company.

Importance of Income Statement

• Income statement provides all the stakeholders with a summary of the company’s performance during the period. All the activity and the quantum of the action performed by the company during the period are summarized in the income statement.
• It is a good statement for comparing the company under analysis with its past year performance and among the peer companies operating in the industry. All the analysts in the industry track the company’s stock using the income statement to analyze the numbers and its peer’s numbers. They can quickly compare the margins and the growth in revenue and expenditure if the income statement is presented in the same format.

• The income statement is also essential for the forecasting purposes of any company. Taking the past performance numbers of the company, the future growth, and the company’s revenue projections are forecasted. For example, in the sample income statement, the finance manager or the analyst can predict the year’s projected numbers by analyzing the past trends of revenue and expenses.

• The income statement also shows the classification of the revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more and the expenses, which shows how each company department is performing. It gives the manager or management a good indication of which company expense is growing at an unexpected rate and which expense needs to be cut down in the future.
• The income statement is vital for ratio analysisRatio AnalysisRatio analysis is the quantitative interpretation of the company's financial performance. It provides valuable information about the organization's profitability, solvency, operational efficiency and liquidity positions as represented by the financial statements.read more, valuation, and equity researchEquity ResearchEquity Research refers to the study of a business, i.e., analyzing a company's financials, performing Ratio Analysis, Financial forecasting in Excel (Financial Modeling), & exploring scenarios to make insightful BUY/HOLD/SELL stock investment recommendations. Moreover, the Equity Research Analysts discuss their findings & details in the Equity Research Reports. read more of the company. The income statement is used extensively by all analysts and research houses tracking the company to analyze, forecast, and perform corporate valuation, which is used to make future economic decisions on the company. Various income ratios like gross margin, EBITDA marginEBITDA MarginEBITDA Margin is an operating profitability ratio that helps all stakeholders of the company get a clear picture of the company's operating profitability and cash flow position. It is calculated by dividing the company's earnings before interest, taxes, depreciation, and amortization (EBITDA) by its net revenue. EBITDA Margin = EBITDA / Net Salesread more, Interest coverage ratioInterest Coverage RatioThe interest coverage ratio indicates how many times a company's current earnings before interest and taxes can be used to pay interest on its outstanding debt. It can be used to determine a company's liquidity position by evaluating how easily it can pay interest on its outstanding debt.read more, and other income ratios can be easily derived from the sample income statement, which is an essential source of analysis.

• The income statement forms a vital part of the annual reportAnnual ReportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company's performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements.read more of a public listed company. Moreover, publicly listed companies are bound to report the financial statementThe Financial StatementFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more of the period ending. The income statement is the most critical part of the three financial accounts as it gives the user the snapshot and the performance result of the company. The cash flow and the balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more are also formed with the help of the income statement numbers.
• Based on the company’s income statement, there are many decisions and business plans that depend on the income statement. For example, the management can decide on inorganic or organic growth. Also, the market reputation and the analyst consensus are very much dependent on the numbers reported on the income statement.

Thus, the income statement serves many purposes and provides valuable insights to various internal and external parties and stakeholders. A company cannot survive or exist without reporting or preparing its income statement. As a result, every business that wants to control and reflect the true picture of the company’s income statement needs to have proper command over the numbers of the finance department.

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This article has been a guide to the Purpose of the Income Statement. Here we discuss the purpose of the income statement for various stakeholders and also the importance of the income statement. You may learn more about accounting from the following articles –

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