Income Statement Analysis: Analyze Your Business Profitability And Current Financial Conditions

By: Josh S. Brown|LRL Writer  

The income statement analysis is mainly to report to investors about the company's earnings over a specific period of time. It is basically a tool for comparing and examining relationships between financial statement elements. Managers use this tool for risk analysis. Analysts, investors and creditors for stocks and bonds use the income statement analysis as a decision making tool. It is a tool that gives information to company officials and outsiders about the worth and position of the company. The general financial statements are required to be published by a company. The income statement also helps to analyze the current position of the company in the market and in making predictions about future position of the company.

The profitability, financial position and liquidity of a company are regularly assessed by financial advisors and brokers to make recommendations about stocks and bonds. The financial analysts compare the income statements analysis of the company with past statements and also with other companies in the market.

There are three types of income statement analysis that are very common;   

They are Horizontal Analysis, Vertical Analysis and Ratios Analysis:  

In horizontal analysis, two or more years of the same company are compared and the percentage changes are computed year-wise. When the number of years is more for income statement then a trend analysis may be applied in which the base year's percentage is assumed to be 100 and the changes that follow are compared.

In vertical analysis, each amount of the income statement is reported as a percentage of the total revenue and each amount on the balance sheet is computed as a percentage of the total assets. The balance sheet becomes a common-sized balance sheet after the restated values are put in and then this can be compared with other company's balance sheets and industry averages.

In ratios analysis, the items on one or more financial statements can be compared by an analyst. On the basis of ratios comparison of the trends of the company over the years and with the industry standards is possible. Ratios can be divided into three main types and they are profitability ratios, liquidity ratios and solvency ratios.

1. Among these profitability ratios can be used to find out a company's operating success.

2. Liquidity ratios measure the company's short term capability to repay debts. 

3. The company's long term obligations are determined by the solvency ratios and the ability of the company to survive over a long period of time.

When an investor is seriously contemplating on investing in a company then the income statement analysis provides valuable insight into the efficacy with which the management is controlling expenses, the taxes paid and the interest and income. In fact the investor can determine financial ratios about the return rate being earned by a shareholder on his/her earnings and assets. The profits made by the company can be compared easily by the profits being made by competitors. An income statement analysis provides a lot of useful information and cannot be ignored by a business person.

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