Purpose of Income Statement

What is the Purpose of Income Statement?

The income statement is the statement of all expense and income over a period of time. Every business when preparing the financial statements starts with preparing the income statement for that period. The income statement forms an integral part of the books of accounts, the income statement serves as an indicator for the business which shows the performance of the company for the period ending every year or whenever the statement is prepared.

• The purpose of the income statement 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 profitability of the company by classification of revenue and expense accrued in the income statement during that period.

Purpose of Income Statement for Various Stakeholders

The purpose of the income statement is also 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 The purpose of the income statement is an account which gives the directors and the executive a very clear picture of the performance of the company 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 the annual report of the company needs to be prepared and published annually before the books are closed. The most important purpose of the income statement is that it serves as a good source of analysis of the investors who are willing to invest their stake in the company. The income statement serves as a good source to do fundamental analysis of the company, the investor can analyze the income statement and can make an economic decision on whether he should invest his stake in the company or not.

#3 – The Lender

The Lender of the company is also an important purpose of the income statement and every quarter the banks or the financial institutions demand the income statement to be submitted for the review of the bank and the utilization proceeds of it. The bank after analyzing the income statement decides whether it wants to extend the limit which is enjoyed by the company or does it needs to amend the sanction terms as per the company reporting numbers

#4 – The Creditors

The creditors of the company who are mainly the short-term creditors like the suppliers and the subcontractor also should have a close look at the numbers reported by the company. The income statement shows the creditworthiness of the company and the capacity of the company to repay its current obligation. The income statement can also serve as an indicator for the suppliers and the creditors whether to maintain the relationship and the credit terms with the company.

Importance of Income Statement

• Most important is that the income statement provides all the stakeholders, the summary of the company’s performance during the period. All the activity and the quantum of the activity performed by the company during the period is summarized in the income statement.
• The income statement is a good statement for comparison of the company under analysis with its past year performance and also among the peer companies operating in the industry. All the analyst in the industry or tracking the stock of the company use the income statement to analyze the numbers and it’s peers numbers. The comparison of the margins and the growth in revenue and expenditure can be quickly compared if the income statement is presented in the same format.

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

• The income statement also shows the classification of the revenue and the expenses which shows how each department of the company is performing. It gives a good indication to the manager or the management on which expense of the company is growing at an unexpected rate and which expense needs to be cut down in future
• The income statement is important for ratio analysis, valuation, equity research of the company. All analyst and research houses who track the company make extensive use of the income statement to analyze, forecast and do a valuation of the company which is used to make a future economic decision on the company. Various income ratios like gross margin, EBITDA margin, Interest coverage ratio, and other income ratios can be easily derived from the sample income statement which is an important source of analysis

• The income statement forms a vital part of the annual report of a public listed company. Moreover, companies who are publicly listed companies are bind to report the financial statement of the period ending. The income statement is the most important 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 sheet are also formed with the help of the income statement numbers.
• Based on the income statement of the company there are a lot of decision and the business plans which are dependent on the income statement. The management can take decision for inorganic or organic growth also the market reputation and the analyst consensus is also very much dependent on the numbers reported on the income statement.

Thus, the income statement serves many purposes and also provide valuable insights to various internal and external parties and stakeholders. A company cannot survive or exist without reporting or preparing its income statement. A proper command on the numbers of the finance department and manager is what is demanded by any business in order to have control and to reflect the true picture of the company’s income statement.

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

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