Auditing and Attestation- Certified Public Accountant (CPA) Practice Exam -

Which financial statement should an investor examine primarily to evaluate a company's profitability?

1. Statement of Retained Earnings

2. Statement of Cash Flows

3. Balance Sheet

4. Income Statement

The correct answer is: Income Statement

The Income Statement, also known as the Profit and Loss Statement, is the primary financial statement that provides information specifically related to a company's profitability. It details the revenues generated by the company, the expenses incurred to earn those revenues, and ultimately the net income or loss for a specific period. By closely examining the Income Statement, investors can assess key profitability metrics such as gross profit, operating income, and net profit margins. The Income Statement allows stakeholders to understand how well a company is performing in terms of generating profits from its sales and operations. It is structured to highlight the core elements of profitability, making it the most relevant financial statement for evaluating how efficiently a company converts revenue into profit. In contrast, the other statements focus on different aspects of the company. The Statement of Retained Earnings provides information on how profits are retained or distributed, the Statement of Cash Flows analyzes cash inflows and outflows, and the Balance Sheet presents the company's financial position at a specific point in time, highlighting assets, liabilities, and equity. While all these statements offer valuable insights, the Income Statement is the most direct source of information regarding profitability.