The financial statements of a company provide a representation of the company's current performance to investors. This information is used to evaluate the overall value of a company and its share price. The income statement is one of the most important financial statements because of its indication of profits, its timely reporting, and its classification of revenues and expenses.
An income statement is important because it offers a recent picture of the company's revenues and expenses and overall profitability. Managers and investors can use this information to make financial decisions.
Purpose of an Income Statement
The income statement is one the major financial statements used to analyze a company. The other important documents are the balance sheet, the cash flow statement and the statement of shareholder's equity. The income statement is used to give a summary of the company's revenues and expenses over a specific period of time. This information is then used to determine the total profit or loss to the company over the stated accounting period.
Indication of Profitability
The income statement is important because it clearly states whether a company is making a profit. The total revenues and expenses of a company are listed on its income statement. Subtracting the expenses from revenues provides the total profit during the given accounting period, usually a year or a quarter of a year. A company must consistently be making a long-term profit for it to be considered a good investment choice. This information can only be found on the income statement.
Timely Updates of Operations
The income statement of a company may be updated on a more regular basis than the other financial documents. Because the income statement provides a clear picture of current profitability, a company's managers and investors constantly review it. This gives the company an incentive to publish its income statement on a more regular basis to help its operations. Whereas other financial statements are published annually, an income statement may be released quarterly or monthly.
Classification of Revenues and Expenses
The income statement also is important because it clarifies the different revenues and expenses of a company. Revenues and expenses are listed according to the business section from which they came. Non-business-related revenues and investment revenues and expenses are also listed. This gives managers a view of how each department is performing, so that if one department is underperforming, it can become the focus of improvement. It also gives investors a better idea of a company's status by separating its business revenues from gains on investments. This information allows for a more detailed financial analysis of a firm.