1.1 BACKGROUND OF THE STUDY
Businesses are in the business of earning income. Their activities do not necessarily coincide with standard periods of time, but the business environment requires that firms report income or loss regularly. For example, owners must receive income reports every year, and the government requires corporations to pay taxes on annual income. Within the business, management uses financial statements – prepared every month or more often to monitor performance. Because of these demands, a primary objective of accounting is measuring net income in accordance with generally accepted accounting principles. Readers of financial reports who are familiar with these principles understand how the accountants defined net income and are aware of it’s strengths and weaknesses as a measurement of company performance.Business rely on profit to buy new inventory, expand operations and finance product development. Without profit, business would stagnate and risk losing its market share to other competitors. Its share price will fall, which means it cannot rise as much money with share sales and cannot borrow from banks as easily. The goal of many businesses is to generate a profit for owners, employees and shareholders. It is therefore imperative at this point to illustrate the definition of income measurement. From accountant’s perspective, income is defined as the residual portion of revenue which is the result of subtracting total revenues generated from the total expenses incurred by the company during the revenue generation phase.
An economist though would beg to differ, by defining income in terms of residual expected cash flows available from consumption, after dividend and equity appreciation has been taken into account although the accountants and the economists view of the income concepts differ, in that one deals with historical values and the other in future expected cash flows, its importance is of vital use. Effectively, management has been entrusted with funds from various sources (shareholders, financial etc) to appreciate its value, and as such. Income is an effective indicator of measuring that. Management’s stewardship on its operating effectiveness of working capital may be best monitored by charting a company’s income pattern. From managerial point of view, income will aid in high lighting the disparities between actual and predicted performance targets