Role of the Income Statement
The income statement is a financial document that shows a business’s profitability by deducting all expenses from revenues. The important characteristics of an income statement include the representation of revenues and expenses within a specified trading period (Huang, 2019). In addition to the company’s name, every income statement must specify the reporting period, which is often the previous business year. Revenues earned during this period come first in the document and include both cash and non-cash income. Expenses that include all the payments the company made during the reporting period such as cost of goods, payroll, rent, amortization, and utilities follow the revenues (Huang, 2019). The document ends with a net earnings figure that shows profit when positive and loss when negative.
Internal and external business stakeholders are interested in the contents of an income statement. Mostly, internal users are the board of directors and upper manager of the company. Externally, existing shareholders, potential investors, creditors, competitors, and financial analysts are keen to use the income statement for various purposes (Huang, 2019). The demand for its information makes the income statement a critical business-reporting tool for managers, CEOs, regulators, and investors.
The income statement conveys profitability information to different users for diverse application. Directors and managers use the content to identify cash flow problems, revenue generation problems, and plan for improvement (Huang, 2019). After identifying challenges, the managers will make decisions to improve the company’s future. Investors utilize it to gauge whether the company is making profits enough to support growth. Creditors analyze the firm’s revenue making process to check if the company can service its existing facilities or take new loans.
Income Statement Questions
- Cost of sales refers to the expenses incurred in purchasing or producing the merchandise sold to customers. Yes, the company has inventory listed in the balance sheet because it is associated with the cost of sales expense.
- Gross profit has great significance because it reveals the efficiency of the firm to utilize its resources such as labor and assets in producing goods or providing services to customers. For example, ABC Company indicates high efficiency with a margin of $325,000.
- Operating expenses are the ongoing cots associated with running the firm or producing goods and offering services (Huang, 2019). They include insurance, rent, payroll, taxes, maintenance and repairs, utilities, office supplies, advertising, and depreciation.
- Yes, ABC Company has employees as indicated by its ongoing business costs. For the reporting period, ABC used $100,000 on salaries, showing that they paid workers during that time.
- An overstatement of the property taxes by $10,000 means that actual cost should be $8,000. Therefore, total operating expenses will reduce by $10,000 and net income will increase by the same value to become $87,000.
- A new manager will increase total operating expenses by increasing salaries, thereby decreasing net income.
New salaries: $100,000 + $80,000 = $180,000
New total operating expenses: $233,250 + $80,000 = $313,250
Net income: ($3,000), which is a loss but after correcting property taxes overstatement, net income would be $7,000.
- It is informative to check the balance sheet to determine if ABC Company has equipment. Although there is a depreciation expense, the income statement does not specify if it relates to plant, property, or equipment. Therefore, only the balance sheet would tell if the firm has equipment.
- Yes, the company has debt because it paid $15,000 in interest expenses during the reporting period. The income statement only shows the interest paid for some debt but the balance sheet would show how much short-term and long-term liabilities the company has.
- ABC uses an accrual basis because it includes the accounts payables and receivables in their balance sheet (Eulner & Waldbauer, 2018).
- At the end of the period, the income statement is closed to the Income Summary account.
Eulner, V., & Waldbauer, G. (2018). New development: Cash versus accrual accounting for the public sector—EPSAS. Public Money & Management, 1-4. Web.
Huang, J. (2019). Data analysis of balance sheet and income statement. Proceedings of Business and Economic Studies, 2(3). Web.