Question

why is it dangerous to rely only upon income statements to evaluate financial performance of companies? what other statements should evaluate?

Answer 1

Relying completely upon Income statement to evaluate financial performance is never a good thing. The reason behind this is that Income statement can be manipulated easily. Different companies follow different practices while preparing Income statement, even within the same Industry revenue recognition practices differ greatly. There are different components of Income where companies follow different approach

Revenue recognition; when is a sale actually being considered a sale and being part of revenue. what about sales return or product warranty cost

Depreciation: Deperciation may vary also from straight line method to written down value. It impacts the income of that year

Expenditure: whether a particular expenditure is being considered a capital expenditure or revenue expenditure.

Inventory; what is the Inventory methodology being followed. This impact the cost of goods sold.

Relying completely on Income statemen to Judge the financial performance is never a good thing.

The others statement apart from balance sheet that should be focused is cash flow statement. The probability of manipulating cash flow statement is very low. The cash flow satement has three parts: Cash flow from operating activities,which measures the cash generated from core business activities of the business, cash flow from Investing activities which measures the cash income generate from the investement or paid for the investment, cash flow from financing activities whic measures the cash generated or paid because of the chnage in capital structure. The Income statement should be evaluated in line with the cash flow statement.