Discuss potential hazards associated with focusing too heavily on the bottom line.
Income statement is a financial statement, which shows the transformation of the revenue into the net income, also known as the “bottom line”. Net income for a reporting period is obtained by subtracting all the losses and expenditures from the revenue. It is often considered in financial analysis as the measure of financial performance for the period. However, there are hazards, associated with focusing too much on the “bottom line”.
One of the aspects one must consider when using the “bottom line” for performance assessment is its tendency to estimate the value of some assets. If the estimates are wrong, net income indicated on the income statement no longer reflects the true performance. Thus, the cost of development is only expected to provide future benefits for the company. If it does not, the “bottom line” on the income statement no longer reflects the true value of the intangible assets. On the other hand, research and development costs are expensed as incurred, which understates the net income without considering the future benefits of the investment. A special example of an intangible asset that is not correctly reflected by the net income is the so called “goodwill”, which is the premium price of a company above the book value. Although the value of the “goodwill” should be amortized, the actual value of the company is not declining. Therefore, net income is understated according to this logic.
Since net income shows only the aggregate value, it is impossible to identify the real reason for its decline or improvement. Thus, if a company has faced major restructuring or an anticipated production problem, it will not be possible to make conclusions about the overall company performance by looking at the “bottom line” only. A similar pattern arises when a company disposes of an asset or writes it down in order to indicate that its current value is below the carrying value. In this case the net income for the reporting period may be larger than usually, especially if the worth of the value was significant compared to the company’s income.
References
Shawn, A. (n.d.). Reported net income versus adjusted net income. Retrieved from
http://www.investorsfriend.com/Netincome.htm
