Importance of income statement
Question Two
Discuss how income statement is useful for helping to assess the risk or uncertainty of achieving future cash flows. An income statement is a financial statement useful in assessing the risk or uncertainty of achieving future cash flows. Assessing the uncertainty of achieving future cash flows would require a clear understanding of a business’s past performance. The data that is used in assessing the risk of achieving future financial outcomes can come from an income statement. Through analysis of historical data in an income statement for given periods, a business’s future profit and losses can be forecast.
An income statement can also be used to forecast future revenues. Once an annual growth has been determined from an income statement over previous periods, the information extracted can be used to assess whether future revenues can be achieved.
Moreover, an income statement can predict the cost of goods sold especially for a service-based enterprise. It can assess the costs related to employment tax and labor to determine whether future cash flows can be achieved.
Through an income statement, past operational expenses can be analyzed and then compared to the expected future revenues to assess whether the expected operating costs will be forecasted.
- What is the section of income statement that comprise gross profit? Explain how it is derived.
Gross profit is the first section of an income statement that is used to determine how profitable a business is after direct costs. Gross profit is the profit that an enterprise makes after subtracting the costs related to making and selling products or providing services. Gross profit is used to determine a firm’s gross margin. In an income statement, gross profit is calculated by obtaining the difference between the cost of goods sold and sales. Gross profit is used to
how efficient an enterprise is in utilizing labor and supplies to generate goods and services. The variable costs considered include raw materials used, direct labor, sales commissions, equipment, and depreciation and utilities among others.
Derivation of gross profit;
Gross profit = Sales – Cost of goods sold