Question

1. What is the purpose of an Income Statement? What are the typical categories and sub-categories for an income statement?
2. What is unearned revenue and when does it occur?
3. What is the purpose of the Statement of Cash Flows?

Answer 1

1. Income statement, also known as a profit and loss statement, is a statement that discloses all the revenues and expenses generated by the company. It also computes earnings after tax after taking into account depreciation, interest, and tax. An income statement is one of the three important financial statements that an organization is required to make. The main purpose of the income statement is to assess the profitability of an organization.

The income statement is generally divided into three categories.

1) Revenue: It includes all the revenue/sale generated by the organization. Here, revenue is reduced by cost of goods sold to get Gross Profit.

2) Operating Expenses: This part of the income statement records all the operating expenses such as salary, wages, other operating expenses. These expenses are reduced from gross profit to get Earning before Interest, Tax and Depreciation.

3) Net Income : To compute net income of an organization, Non-Operating expenses such as depreciation, interest and tax are reduced from EBITDA. This shall give us Net Income.

There are the basic categories of Income Statement.

2. Unearned Revenue means money is received by the organization but obligation the provide product or service is pending. For example, Pre booking payment for car is made and car manufacturer is yet to provide the delivery of the car.

Since it is a obligation the perform in future, Unearned revenue is considered as liability of the organization.

3. Statement of Cash Flows records cash transaction taking place during the financial year. Cash flow is calculated according to operating, financing and investing cash flows.

Purpose :

Usually, the income statement is made on accrual basis i.e.. Salary Outstanding is considered as an expense, however there is no cash transaction taking place as the salary is outstanding is yet to be paid. Therefore, business analyst wants to know what is the actual cash flows of the company apart from the net income they have generated. If the company has high net income but low cash flows than its a problem.