How Net Income Conveys Information About the Performance of the Firm

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How Net Income Conveys Information About the Performance of the Firm

Nowadays, financial statements provide the investors, public, and management with information about the performance of the firm, and one cannot underestimate the significance of net income in the interpretation of the results, as net income can be defined as a financial value, which represents the actual profit of the firm (Weil, Schipper, & Francis, 2013). It excludes taxes, production costs, and other expenses from the revenues and provides a clear understanding of the companys stability since net income plays a critical role in evaluating a firms sustainability and performance. (Weil et al., 2013).

There are several arguments that support the gravity of net income for investors, management, and stockholders, and in the first place, net income offers a clear understanding of the firms actual performance, as deducting different variable and fixed costs gives a company a general understanding of its profitability (Weil et al., 2013). In this case, evaluating net income is one of the first steps to assess the firms functioning by investors and acquirers, as it helps get a general perception of the organizations stability and determines whether it is reasonable to continue partnership or acquisition. (Weil et al., 2013).

Furthermore, one cannot underestimate the impact of net income on other components of the companys financial statements since net income has a clear correlation with the value of retained earnings. Retained earnings represent a share of net income used for the reinvestment in the business and optimization of its processes, and it provides information about the companys ability to meet its strategic goals and pursue its development and expansion strategy (Gibson, 2012).

Alternatively, to support its influence on other elements of the companys financial performance, one cannot underrate the connection of net income and retained earnings with the stockholders equity. As it was mentioned earlier, net income forms a state of financial resources, which can be spent on the development of the company, and another part of net income forms stockholders equity leading to a substantial rise in equitys value (Gibson, 2012).

At the same time, having information about net income gives an organization an opportunity to project future cash flows with the assistance of adjusting this financial matter to irregularities (Kimmel, Weygandt, & Kieso, 2016). In this case, the financial department of the company can modify its expenditures and sources of revenue to reach the desired goals, as systemizing net income for several months might help understand market trends and build potential associations with the companys profitability and economic cycles.

References

Gibson, C. (2012). Financial reporting and analysis: Using financial accounting information. Mason, OH: South-Western Cengage Learning.

Kimmel, P., Weygandt, J., & Kieso, D. (2016). Accounting tools for business decision-makers. Hoboken, NJ: John Wiley & Sons.

Weil, R., Schipper, C., & Francis, J. (2013). Financial accounting: An introduction to concepts, methods, and uses. Mason, OH: South-Western Cengage Learning.

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