What is income statement analysis?

Income statement analysis is the assessment of the revenues recognized for a specific period and the cost and expenses charged against these revenues in their transformation into the net income.  The income statement reports the results of an entity’s business activities for an accounting period by showing its revenues, expenses, gains and losses in arriving at the net income or loss for that period.

Income statement analysis involves the comparison of the different line items within an income statement and following trend lines of the individual line items over multiple periods in arriving at the incremental measures of profit – gross profit, operating profit and net profit.  It allows an assessment of the cost structure of a company and how the various components of the income statement affect the company’s ability to earn a profit.

A company’s ability to meet its short- and long-term debt obligations out of its operating cash flow as they come due for payment is solvency.  The going-concern concept is based on the assumption of a solvent business.

A company’s cash flows from operations is its net cash inflow resulting directly from its regular operations – disregarding extraordinary items, such as the sale of fixed assets or transaction costs associated with issuing securities, equaling the firm’s operating revenue less operating expenses plus noncash expenses (depreciation and amortization):

Operating Profit + Noncash Expenses

Cash flow is essential for the firm’s solvency and survival and must be adequate to ensure that creditors, employees and others can be paid on time.  In addition to servicing debt, cash flows from operations are needed for investment purposes.