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. It plays an important part in the decision-making process because, based on it the management decides the current position, future business prospects, viability of any strategy implemented, or possibility of growth and expansion.  

• The purpose of the income statement is to display the company's performance in a given period to the investors and assist the company's value which may influence the share price.
• It is a reporting tool for management, investor, lender, and creditors.
• A company can only sustain itself by reporting or preparing the income statement. Therefore, every business wanting to control and reflect the company's income statement must possess appropriate control over the finance department numbers.

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 comprehensive 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 of comprehensive 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 company’s profitability by classification of revenue and expense accrued in the income statement during that period.

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. Therefore the purpose of income statement and balance sheet  is to give 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 to the above purpose of income statement and balance sheet, 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

Another main purpose of income statement is that every quarter banks or financial institutions demand the income statement be submitted for 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, which is one of the main purpose of income statement. It also serves as an indicator for the suppliers and the creditors to maintain the relationship and the credit terms with the company.

• 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 action performed by the company during the period are summarized in the income statement.
• A purpose of income statement in accounting is that it is a good statement for comparing the company under analysis with its past year's 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.

• Another purpose of income statement in accounting is that it also shows the classification of the revenue 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 analysis, valuation, and equity research 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 margin, 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, publicly listed companies are bound to report the financial statement 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 sheet 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.

This article has been a guide to what is the Purpose Of Income Statement. We explain the purpose for each kind of stakeholders along with the importance to them. You may learn more about accounting from the following articles –

• Tracking Error Formula
• Credit Terms
• Top 4 Types of Coverage Ratio
• Partial Income Statement