Why Income Statement is Important? 5 Points You Should Know

Investors invest in companies expecting returns and income. Usually, companies pay dividends which can constitute earnings for investors. On top of that, some companies may also provide capital gains through increasing share prices. However, investors must first investigate the company to ensure it can offer those returns. The primary source they can use is the company’s financial statements.

Financial statements are written records of a company’s operations. Instead of showing those operations qualitatively, these records focus on monetary terms. Usually, companies prepare four primary financial statements. These include the balance sheet, income statement, cash flow statement and statement of changes in equity. Each of these presents a different aspect of the company’s records. On top of that, they also follow specific formats.

For most investors, the primary source of financial information is the income statement. Since this statement focuses on financial performance, investors may prefer it over the others. On top of that, this record is also straightforward to understand and analyze. The income statement is of significant importance for companies and investors alike. However, it is crucial to understand what it is and what it represents.

What is the Income Statement?

The income statement is a financial statement that reports on a company’s profitability. This statement tracks various items for a specific period. Based on those items, it shows how profitable the company has been due to its operations. The income statement also follows a specific format provided by accounting standards. Usually, it is the first financial statement that companies prepare. On top of that, it also supplements the other statements.

The income statement is one of the most crucial documents for investors. Usually, most investors examine how profitable a company is before investing in it. The income statement provides that information and can help them understand how the company works. The other financial statements are also critical. However, the income statement can provide substantial information about the company’s financial performance.

Related article  Consistency Principle (Definition and Example)

Companies use the income statement to attract investors. However, they must perform to back their claims in this record. On top of that, this statement can help investors understand how a company operates by presenting critical aspects of its operations. As mentioned, this illustration occurs through monetary terms, which can be helpful. However, companies prepare the income statement under the accrual concept, which can be confusing.

The income statement reports on three critical aspects. The first includes revenues which shows how much sales it has made. Secondly, it also shows its expenses, which are crucial in establishing how much a company spends. However, investors must consider these expenses with the revenues they help generate. The income statement also reports profits, depending on the other two aspects.

Overall, the income statement is a document that shows a company’s financial performance. It is crucial in helping investors understand how a company operates. On top of that, it also provides insights into the revenues and expenses a company makes. Through these aspects, the income statement also shows how profitable operations are. These aspects make the income statement highly important.

Why Income Statement is important? 5 points you should know

The income statement is a highly crucial document that comments on a company’s profitability. It is also a part of the four critical financial statements that companies prepare. Apart from being mandatory, the income statement also has more significance. Most investors consider this statement before others, making it highly critical for companies.

The income statement has various advantages and benefits. In most cases, these depend on how investors use them. Apart from being mandatory, the income statement has other reasons for importance. Of these, the 5 points that show their importance include the following.

Presents revenues

A crucial part of any company’s financial performance is its revenues. This figure represents the income a company generates during an accounting period. Usually, companies may also earn from other sources. However, revenues are money made through operations. For example, they may include the sale of products and services. While investors prefer income from all sources, revenues are more critical as they relate to the activities of a company.

Related article  What Does Materiality Mean in Accounting? (Definition, Explanation, and Examples)

The income statement presents revenues as the first line item under the accounting standard format. These revenues are crucial in helping investors understand the total income from operations. On top of that, it also helps set the overall figure from which companies deduct expenses. Revenues play a critical role in determining how profitable a company is. Overall, revenues are one of the crucial aspects of the income statement.

Presents expenses

While most investors emphasize revenues and income, expenses are critical in profitability. The income statement shows how much a company spends to generate its sales. Usually, these expenses relate to operations. In some cases, they may also come from financing or investing activities. Either way, these expenses are crucial in explaining the primary outflows for a company.

Expenses are essential in generating revenues. Companies cannot expect to make sales without spending first. However, they can also reduce profits, which can be critical. The income statement presents expenses in various categories. This categorization can also help determine various types of income. On top of that, it can also help investors understand the different areas where spending is crucial.

Calculates profits

The most critical aspect of the income statement is its profit calculation. It is one of the primary objectives of this statement. As mentioned above, profitability is the primary concern for investors who use the income statement. The above two aspects determine the profits a company makes for a period. Usually, companies calculate various types of profits, representing different areas.

Profits are crucial for companies to survive in the long run. An unprofitable company cannot last forever. Usually, the higher these profits are, the more likely it is to attract investors. On top of that, a company’s share price also depends on its performance. The income statement shows that area and can help show profitability to investors.

Related article  Revenue Recognition Principle (IFRS): Definition, Using, Formula, Example, Explanation

Allows comparison

One of the critical importance of the income statement is that it can help compare performance. This comparison can occur between its competitors or the industry. On top of that, investors can also compare the company with its past results. By doing so, investors can understand if the company has improved or declined its performance.

Comparability is a part of all financial statements. However, comparing the income statement is more straightforward than the other statements. Usually, investors can see how the revenues, expenses and profits changed. In those cases, no other underlying factors can impact those figures. The other statements may be more challenging to view comparatively.

Helps in forecasting

The income statement directly relates to a company’s operations and activities. When forecasting for these, this statement can provide significant benefits compared to others. Usually, companies must estimate their revenues and expenses to budget their future needs. These elements are a crucial part of the income statement. Usually, this forecasting occurs internally.

Companies can also use the income statement to prepare forecasts for external stakeholders. Sometimes, creditors and lenders may request these items. The income statement is the most critical forecast that helps understand a company’s plans. Based on that information, they can decide how they interact with the company.

Conclusion

The income statement is one of the four financial statements that companies prepare. However, it is more critical for investors as it deals with profitability. This statement is of high importance to all stakeholders. It shows three elements, which include revenues, expenses and profits. These factors are crucial in dealing with various stakeholders.