The income statement in other words known as the profit and loss account is one of the most important financial statements prepared in any business enterprise. It is prepared on an annual basis and shows the profit or loss in a gross or net form that the organization has achieved in the course of the financial period. In, essence, the income statement is the core financial statement in any organization because almost all the financial statements use data from this report in their preparation and analysis (Nikolai et al, 2009, p.139). The income statement entails three main components namely; revenues, expenses, and profits. The difference between the revenues and expenses is what leads to the profits or losses of the organization. The revenue comprises all the money that comes into the organization in the form of sales, discounts received interests earned and rental incomes among others. Expenses are the other elements of a typical income statement that reduce the revenue. Most of the expenses are incurred in the running of the organization and include; advertising, insurance, rental fees, employee salaries just to mention but a few. The last important element of a typical income statement is profit or loss. This is derived from the difference between the revenue and the expenses incurred during the trading period.
The expenses are likely to present more challenges during the computation of a typical income statement. This is mainly because of their infrequency of occurrence as well some that occur as a result of unusual causes in nature. This leads to extraordinary items in the balance sheet which proves to be a challenge in the preparation.
Comparison of the uses of the income statement and balance sheet
The balance sheet is another common financial statement that is prepared to show much the organization is worth at a specific date by indicating the financial position of the organization (Nikolai et al, 2009, p.138). The income statement or rather the profit and loss account shows the profit or loss in the net or gross that has been gained during the financial period. This, therefore, shows that the balance sheet is prepared as at a specific date while the income statement is prepared for a certain trading period which could either be quarterly, half-yearly, or annually depending on the organization. The balance sheet gives a list of the assets, liabilities, and capital equity of the organization while the income statement shows the revenues, expenses, and profits of the organization (Peavler, 2011, p.1). The balance sheet is usually prepared after the income statement since it uses the earnings figure to balance off its equity section. Other than differences, the income statement and balance sheet have some correlations whereby a change in the net income leads to a simultaneous change in the net income. At the same time, an increase in the revenues makes the assets in the form of cash or accounts receivable increase and hence the equity. If the expenses increase the assets (cash) decrease while the liabilities (accounts liabilities) go up resulting in a decrease in the equity.
Relationship between cash flow statement and working capital
The statement of cash flow is among the most tedious reports to prepare. It shows how much cash is available in the organization to settle the short-term liabilities for example accrued salaries and short-term assets such as current expenses (Hales, 2005, p.90). This is usually indicated by monitoring the flow of cash in and out of the organization. Working capital on the other hand is the amount of cash that the company uses to pay its stakeholders. The working capital is required to be always available in the organization and thus has to be monitored using the cash budget or the cash flow statement. For this reason, working capital and the statement of cash flows have some correlation whereby an increase in the working capital of an organization indicates that the organization has invested more cash hence reducing the cash flows (Hales, 2005, p.96). Thus if an organization manages its working capital well its cash flows will similarly be effective hence having a positive figure of the cash flow statement.
Recommended changes on the financial statements
Even though financial statements are prepared by the international accounting standards and give the required results additional changes are recommended and if only they improve the reporting of accounting information An example of a change that could be made on the balance sheet is the omission of goodwill amortization. Alternatively, annual impairment tests on the assets could be performed to find out if the goodwill is still present. Another recommendable change concerns intangible assets whereby they should be amortized if at all they are identifiable. This way they will be grouped as capital assets in the balance sheet hence clarifying the subject of intangible assets (Schroeder et al, 2011, p.206). These changes will improve financial reporting by minimizing the inconsistencies that have been encountered in the past.
Hales, J. (2005) Accounting and financial analysis in the hospitality industry. Web.
Nikolai, L., Bazley, J. and Jones, J. (2009). Intermediate Accounting. Cengage Learning. Print.
Peavler, R. (2011). The Accounting Equation. Web.
Schroeder, R., Clark, M and Cathey, J. (2011). Financial accounting theory and Analysis: Text and cases (10th ed.). Hoboken, NJ: John Wiley & Sons.