The purpose of the income statement

The purpose of the income statement is to show the reader how much profit or loss an organization generated during a reporting period. This information is more valuable when income statements from several consecutive periods are grouped together, so that trends in the different revenue and expense line items can be viewed.

The income statement contains several subtotals that can assist in determining how a profit or loss was generated. The gross profit is derived by netting revenues and the cost of goods sold together, and provides an indicator of the ability of a business to set price points that customers will accept, and to maintain the cost of the goods and services that it provides. The other key subtotal is the operating profit, which is the gross profit minus all operating expenses (such as selling and administrative expenses). This subtotal reveals the ability of a firm to generate a profit before the effects of financing activities are factored into the final profit figure.

The purpose of the income statement may differ somewhat, depending on the user. An investor wants to see a consistent profit that proves the viability of the business. A lender is most interested in a business generating a sufficient profit to pay for interest expenses and a return of the loaned amount.

Unfortunately, the profitability of a business can be skewed by fraudulent transactions that can alter the reported amount of revenue or expenses, resulting in a profit or loss figure that does not represent the actual earnings capabilities of the business. For example, someone interested in falsely claiming a high profit figure could capitalize certain assets so that they are not charged to expense until a later period. Or, the individual could recognize a customer advance as revenue, even though the related product has not yet been produced or shipped. Thus, fraudulent intent can interfere with the purpose of the income statement.