Uses of Income Statement

Various uses of income statement are explained under the following headings:

(i)    Earning that can be withdrawn:

Income statement helps in the calculation of the amount of net income which one can spend and still be as well off as before. It is this amount that the owner(s) can take out of the business and still leave the capital intact. In the absence of this statement, the owner(s) cannot precisely determine how much income he/they can use leaving the business in as good a position to earn income as it was at the beginning of the period in question. Though useful, this interpretation of the income figure might cause some complications. For example, net income figure calculated in a traditional manner ignores price level changes, which affect the purchasing power to a great extent. It is due to this factor that most business units do not withdraw whole of their income. The following points must be kept in mind in this regard:

(a)    Some income must be retained to meet unusual losses so that the capital is not unnecessarily reduced.

(b)    Retained income is an important source of internal financing.

(c)    When price levels rise, more money is needed to replace the depreciated assets. There would not be much difficulty if a part of income is retained to counter the effects of rising price levels.

(ii)    Basis for income tax calculation:

Taxes on income and other items have become very significant. This has created a need for every business entity to establish some system for the measurement of income. Various tax regulations have become increasingly specific as to what constitutes income for tax purposes. The income statement provides the basic data for calculating business income although the figure of income on which the tax is calculated often is not the same as the net income figure in the income statement; most tax laws approve and even guide the practices currently adopted by accountants in preparing general financial statements.

(iii)    Basis for investments decisions:

The growth of the joint stock companies from of business organization has created a gulf between management and ownership. The majority shareholders have no direct participation in the affairs of the business enterprises. The average shareholder, therefore, requires financial data to evaluate the worth of his investments. The net income figure, therefore, is of great help in this regard. The income statements show what the business enterprise has been able to earn over the past years and are of great importance in estimating what level of earnings it may be able to achieve in future. Although the prospects for future income are significant, it is necessary to know about the past income data before predicting future earnings. Accordingly the trends of revenues the trends of significant expenses relative to revenues, and the existence of unusual income or expenses are all analyzed before a decision to invest is made.

(iv)    Increased managerial uses:

Not only has there been greater use of income statement by outsiders but the same can also be said for the management. In the past, the owners could be easily find out the earning prospects of their business units, but today in most situations, the complexity of modern business makes this impossible. Managements of large and growing corporate enterprises dealing in many different lines of production, need to have profitability information, to answer questions relating to past, present or future programmes.

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