What is the Purpose of Income Statement?
Income statement is one of the important financial reports of company which is prepared with the purpose of providing the summary of all the revenues and the expenses over the time period in order to ascertain the profit or loss of the company and measuring its business activity over the time period depending upon various requirements of users of income statement.
The income statement is the statement of all expenses and income over some 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 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 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. in the income statement during that period.
Purpose of Income Statement for Various Stakeholders
The purpose 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. It 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 crucial 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 a 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
Every quarter the banks or the financial institutions demand the income statement 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 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 with a 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 are summarized in the income statement.
- It 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 analysts in the industry or tracking the stock of the company use the income statement to analyze the numbers and it’s peer’s 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 essential 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 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. 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 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., valuation, 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. of the company. All analysts 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 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 Sales, Interest coverage ratio, 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 report of a public listed company. Moreover, companies who are publicly listed companies are bind 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. 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. are also formed with the help of the income statement numbers.
- Based on the income statement of the company, there is a lot of decision and the business plans which are dependent on the income statement. The management can decide for inorganic or organic growth. Also, the market reputation and the analyst consensus is 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 to have control and to reflect the true picture of the company’s income statement.
This article has been a guide to the Purpose of 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 –