Income Statement Fundamentals
An income statement is among the three major financial statements that enterprises prepare. It makes available a record of an entities revenues and expenses for a given duration and hence its serves as a basic measure of profitability (Carl, 2008). As a matter of fact, it often is referred to as a profit-and-loss statement. In general, an income statement can be defined as a scorecard that provides a summary of revenues and expenses incurred by a business enterprise for a specified duration. It is therefore an important tool that managers can use to aid their daily operations within a firm.
According to Erich (2001) an income statement reveals information critical to a firm’s operations as well as profitability. Essentially, it is a financial tool that managers can use to evaluate how successful their business operations are towards fulfillment of its prime objective, which most often than not, is to make profit (Carl, 2008). A variety of management decisions are made on basis of this statement. Managers can constantly review product pricing on basis of profitability and growth recorded. It basically allows managers to evaluate how effective the adopted pricing strategy has helped the company attain its objectives (Erich, 2001). Other than face value analysis, managers can obtain various financial ratios from the income statement and use the same to justify decisions made during a trading period.
Managers look beyond the company’s earnings as displayed in the income statement. The document provides insightful information for effective business management including: expenses control, the amount of interest income and expenses received/paid by the entity as well as taxation levels (Erich, 2001). By calculating the financial ratios, managers are able to establish the rate of return an enterprise is earning as well as how well the assets are managed. Additionally, the ratios allow managers to compare their entities performance to that of others within the industry. Such ratios include: gross profit margin, net profit margin and operating profits margin among others (Carl, 2008).
Understanding financial statements is crucial to both current and future positions of the business. It acts as a basis for evaluation of the current position of the business. The income statement can be used as a tool for review of financial information and hence ensure that the business generates adequate capital to pay for its expenses and at the same time remunerate the owner with profit (Erich, 2001). In context of tax business, the income statement can best be used to evaluate if the interest on tax income generated is able to meet its expenditure and also generate profit for the business financiers. The statement is also a useful tool in projecting future scenarios and hence planning. The financial ratios obtained using information from the statement is used to compare it against other industry players (Carl, 2008). This allows restructuring to allow the business compete efficiently. For instance, a tax business may have to review its interest income rates on collected tax in order to cater for its expenses, earn profits to its financiers and at the same time remain competitive within the market.
In conclusion, it’s important to reiterate that an income statement is an important tool that a business cannot afford to without. Its offers a base upon which decision making is made. Entrepreneurs and managers draw vital information from this statement and use it to make crucial decisions. After all, revenue and expenses are the key variables that determine the level of success of a business and fortunately enough, financial statements highlight the two.
Carl, W. (2008). Survey of Accounting. Cincinnati: South-Western College Publication. pp. 128–132.
Erich, H. (2001). “The Nature of Financial Statements: The Income Statement”. Financial Analysis – Tools and Techniques – A Guide for Managers. London: McGraw-Hill. p. 40.