An income statement is a financial statement that is issued by an organization. It is intended to report on the financial performance of the company over a specific time period. Most income statements reflect the accounting periods which are utilized by each firm.
The financial performance that is assessed through the income statement involves a summary of the revenue and expenses created from operating and non-operating activities. When these figures are compared, then it will show if a net profit or a net loss occurred during the period being examined.
Companies of all size can benefit from the production of an income statement. There are also certain reasons why an income statement can be more trouble than it is worth. Here are the advantages and disadvantages of income statements to review.
List of the Advantages of an Income Statement
1. It offers a glimpse at revenue information for the company.
One of the primary advantages of the income statement is that the information provided is directly related to the revenues of the organization. It is a thorough document which takes people through all the revenues and expenses that are incurred over the evaluation period. It goes beyond operations, including taxes, expenses, and interest payments. There is no better document to examine the complete revenue information for the business.
2. It allows for investor analysis.
The income statement makes it easy to see how financially healthy a company has been over a specific time period. Certain key figures, such as the net income or earnings per share, are directly stated on the document, which reduces the amount of research required by the investor. When earnings per share or net revenues are higher, then the company is on a health trend. If not, then you’re able to create some judgments as to why.
3. It is a way to track the performance of the company.
What the income statement ultimately provides is a look at the overall bottom line. A business that is showing a profit is usually doing something right. If not, then they may be doing something wrong. When you review income statements over a long time period, you can begin to track the overall performance of the company. Multiple statements which are compared will negate some of the disadvantages of this document because you’re able to spot trends and eliminate one-time charges that may affect the data.
4. It can be used as a tool for forecasting.
The income statement becomes the foundation for a forecast of future accounting periods. These forecasts are used to generate budgets for the company that may stretch out to 12 months, 5 years, or even 10 years, depending on what is being evaluated. These statements are used to anticipate problems that may creep up in the future, allowing the company to develop a response plan to the situations that the income statement indicates are possible. That makes it easier to deal with a problem before it becomes too serious.
5. It can make your tax reporting responsibilities much easier.
This benefit applies mostly to sole proprietors, general partnerships, and some SMBs. When you report your business income with your personal income taxes, the income statement is a very useful document. It gives you the information needed for the line items you must fill out on your taxes. Instead of adding up every income or expense line, you have a report which gives this information to you already. Just fill in the blanks and include the income statement as part of your filing if recommended.
6. It can be released in two common formats.
There are two types of income statements which are commonly released by businesses today. The first is the single-step income statement, which is the most common. The design of the single-step format clearly shows revenues, expenses, and your income calculations. On the multi-step income statement, the items appear differently, with their calculations, which ultimately provides more data to the reviewer at the expense of being more difficult to read.
7. It is a tool that lenders use for future financing opportunities.
The income statement is one of the financial statements lenders want to review. If you need to find external financing for a project, this statement will offer lenders a look at your overall financial health. They will want to see the financial trends of the company as well to develop a risk profile. If you can show consistent net revenue growth and profits that continue to increase, then you’re likely to receive a lending product with a lower interest rate. If not, then you’ll face high interest rates or be denied financing outright.
8. It measures the success or failure of specific budget areas.
The income statement is a useful tool to measure the overall health of a company. It can also be used to determine the overall health of specific departments in the company. You can use the information from this financial document to look at how well specific budget lines are performing. That information gives you the opportunity to develop a response to certain situations or keep pushing forward when better profits are being experienced over an evaluation period.
9. It allows you to identify potential competitive advantages.
Most companies will generate an income statement that you can find somewhere. Public companies are usually required to release this information. Private companies and non-profits will usually release this data to interested parties or stakeholders. When you can review one income statement with another from a competitive organization, it becomes possible to identify potential competitive advantages where future revenues could be generated. You may also be able to identify where the competition is outperforming your company, allowing you to shift resources to either become more competitive or to look at different ways to be profitable in other areas.
10. It can provide an overview of your cash flows.
When you’re a small business, where your cash is flowing may be even more important than the assets you hold or the profits you’re able to achieve. You don’t have the deep pockets necessary to handle large one-time charges to the income statement. By looking at where you’re receiving cash, and where it is going out of your company, you can better see how you’re using your resources. That makes it possible to make adjustments, cutting down on costs, and ultimately saving some cash access for the future.
List of the Disadvantages of an Income Statement
1. It can misrepresent the value of the company.
Income statements also include money that is due from accounts receivable. Those are funds which have not yet been received. It will also include liabilities as an expense, even if they haven’t been paid. When there is a large one-time expense or a one-time revenue surge, the income levels are driven upward or downward sharply over where they normally would be. That makes it easier to mispresent how successful, or how poor, a company is performing over the review period.
2. It does not evaluate non-revenue factors for success.
The income statement only looks at the revenue outcomes of activities. It does not look at how the company earns sales from its customers. It doesn’t review how the wages being paid compare to similar businesses in the region. There are many practices which can improve or degrade the reputation of a business which are not reflected in the data that is presented on the income statement.
3. It is a report that is generated very frequently.
Although some companies produce an income statement just once per year, a quarterly income statement is very common. Some companies produce an income statement every month. Thanks to the numerous software options and computerized accounting systems that are available to businesses of all sizes today, an income statement can report information in real-time. If small blocks of time are being analyzed, the information can be misleading because there isn’t a data sample large enough to look at.
4. It may not report true costs.
When assets are held on a balance sheet, then they depreciate over their useful life. The Motley Fool uses the example of computer equipment being depreciated by Microsoft. If $100 million in computer equipment is purchased for Microsoft employees, depreciated over 24 months, the income statement would take a $50 million charge for the next two years. In reality, that equipment is going to last longer than 24 months, which means the depreciation expenses on the income statement are not always a true reflection of the costs that are incurred.
5. It can be filled with numerous assumptions instead of facts.
We like to think of the income statement as being a list of financial facts that can be used to gauge the health of the company. For some companies, this is absolute truth. Then there are companies like Walmart, which reports a line of expected returns. If shoppers return more or less products than expected, then the actual net income for the company could be much higher or lower than actually reported.
6. It still requires time to prepare and consume.
Even if software can instantly generate an income statement for you, it takes time to prepare this statement. Figures must be implemented into the software to generate the report in the first place. Receipts may need to be scanned. You may need to ask the income statement to include specific items within the report. Because each category is income-separated, it also takes time to analyze the data on the report to determine is accuracy and benefits.
7. It provides information that can be used against you.
You’re not the only one looking for a competitive edge. Just like you might be trying to review an income statement from a close competitor, they might be trying to review the ones you’re generating. They can use the data you release in the same ways that you are using your data. That means the information in the income statement can sometimes be used against you if a competitor is able to recognize a potential opportunity from their end that you have not yet recognized.
8. It may not always provide useful information.
Although the information on an income statement is generally useful in some way, very small businesses may not find much of a need to produce this financial document on a regular basis. If your income comes from one basic source, and you have 1-3 basic expenses that have a consistent cost, then your financial picture is very predictable. The only benefit to producing this document would be to offer others a look at your long-term consistency. If you’ve just started your business, you wouldn’t even be able to provide that.
The advantages and disadvantages of an income statement provide a look into the financial health of an organization. Although this document does not cover all aspects of the business, it does cover every budget line. That is why it is such a useful tool, but it must be used with other evaluation documents to maximize its effectiveness.