A major purpose of the income statement is to show a firm’s profitability, yet it also provides a number of additional performance measures. Revenue, for example, is a key measure of growth that reflects a firm’s success in expanding its market. Additionally, comparisons of expense numbers from year to year indicate a firm’s success in controlling costs. As previously mentioned, operating income measures managers’ performance in conducting a firm’s operations.
Income statement information provides the basis for a variety of decisions. Because earnings underlie a firm’s ability to generate cash flows for dividends and growth, equity investors are interested in the income statement. Lenders are also interested in the income statement because a firm’s ability in a timely manner ultimately depends on its profitability.
A firm’s management can use income statement information to make a variety of decisions. For example, managers must constantly evaluate the prices they set for the firm’s products and services. Pricing affects both profitability and growth. The income statement tells managers and investors how well the firm’s pricing strategy has accomplished stated objectives.
Corporations always strive to reduce the costs of their operations, and the income statement can also measure the success of cost-cutting initiatives. However, costcutting, such as employee layoffs, do not ensure increased profitability. Apple Computer Inc. cut thousands of jobs in 1996 and 1997, yet continued to post losses. Continued competition from industry rivals and the loss of human talent are issues that must also be addressed.
As a final illustration, managers often use the income statement when setting dividends. Net income is a primary measure of a firm’s ability to pay dividends. In fact, some firms set a dividend target equal to a certain percentage of net income.