Importance of Income Statement and Balance Sheet

The income statement called the statement of earnings reports the amount of net income earned by a company during a period. Almost every day The Wall Street Journal contains report of net income or earnings figures announced by companies the day before. Stock prices go up or down depending on whether their announced earnings meet investors’ expectations. For instance if there was an increase in the price of share of a specific company the increase is compared to net income of the previous year. This high level of interest centered on net income makes it apparent that investors find this accounting number useful in evaluating the health and performance of a business. (Albrecht, 2002)

Net income is reported on the income statement. The income statement shows the results of a company’s operation for a period of time. The income statement summarizes the revenue generated and the cost incurred to generate those revenues. Income statements seek to differentiate revenue and expenses which is net income. Let us examine the various aspects of the income statement and their effect on the income statement. (Albrecht, 2002)

Revenue

Revenue the amount of assets created through business operations, owner’s investment, and borrowing. Products sold or services rendered generate revenue. Companies can also generate revenues through rents or charging interest. When goods are sold or services performed revenue is generated as cash or accounts receivables if there is a promise to pay at a certain date. Revenue in these instances increases total assets. The new assets are not tied to any liability and therefore represents and increase in the owner’s equity. (Albrecht, 2002)

Expenses

Expenses are the amount of assets consumed through business op...

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Equity

Stocks $18,000.00

Retained earnings $8,000.00

Total Assets $32,000.00 Total Liabilities +equity $32,000.00

Although the balance is useful, it has its limitations. The primary limitation of the balance sheet is that it does not reflect the current value or worth of a company. In essence the importance of the balance is that it provides the financial position of a company on a particular date. It helps external users assess the financial relationship between assets, liabilities, and the owner’s equity. Assets and liabilities are usually classified as either current or long term and presented in descending order of liquidity. (W. Steve Albrecht, 2002)

References

Albrecht, Steve W. et al Accounting Concepts & Application (8th edition ed.). Cincinnati, Ohio: South Western. (2002).