Types of income statement

The income statement is one of the main financial maps that every entrepreneur should know how to analyze (truth be told: any person that somehow deals with management, accounting, finance or any related field must know how to interpret an income statement).

The income statement summarizes the revenues and the costs that a company incurs and, as result, it provides the profit (when the revenues are higher than costs) or the loss (when the company sustains more costs that what it earns). So far, it’s quite intuitive.

As accounting procedures evolved through time, the same occurred with how the income statement is organized. Each country has its own accounting principles that direct how the income statement should be structured. Independently of the procedures within each country, there is usually two forms of presenting the items of the income statement: the income statement by nature and the income statement by functions.

So, what’s the difference?

The income statement by nature presents each item of the income statement according to its… well, to its nature! By nature it means that expenses are grouped according to their type: all expenses related to human resources are together, the same happens with the raw materials that are used on a productive process, or depreciations; all costs are grouped by their type. On the revenue side items are also grouped by their nature or type: gains from sales or services are separated from other types of gains such as subsidies.

On an income statement by functions, items are grouped according to their use within the company and not by their type. An example:

The costs with human resources are not grouped together but according to the function that each person has on the company. The salary and other costs of the administrative personnel may be set into an administrative category. And other expenditures from other natures that are mainly administrative will also be input into that category.

The categories within an income statement by nature are pretty much equal across every company that follows the same accounting standards. But the divisions of an income statement by functions can vary more from company to company as the function’s division will tend to be organized according to each company’s business.

Which one is better or which one should be used?

As you may imagine, there is no “right answer” to this question. The income statement by functions gives a better image of how the company is managed (or is intended to be managed when in forecasting), because it shows if a company is spending more on administrative, on sales, on research or on productive items. Most often, business analysts and investors prefer to analyze a company from its business perspective and for that purpose, an income statement by functions is better.

But sometimes, analyzing the natures of the expenditures is also relevant and, in several countries,  it is the official presentation of the income statement for tax authorities and other government agencies.

The income statement at CASFLO APP

At CASFLO APP you can you use both forms of income statement, although “by functions” is only available for Full Plan users. The functions that one can choose are: i) cost of goods sold, ii) general and administrative, iii) sales and marketing and, iv) research and development.

You can learn more about the income statements at the Learning Center. The accounting and reporting manual explain how the income statements are organized at CASFLO APP and it also has an extensive presentation on every item within each income statement. There is plenty of information for you to shine on you forecasting!

The difference between investment and costs

For many of us out there who have had the opportunity to learn or to work on accounting, this is something that is quite obvious. Yet, over the past years we have noticed that many entrepreneurs who have not had any experience with management or accounting tend to confuse these two concepts when doing their feasibility analysis for the first time. As a result, they end up stating costs that should be deemed as investment and vice versa. So, what is the difference?

Investment

The investment is the expenditure that a company (or an individual) does in long-term productive assets. Examples:

  • Machinery
  • Building and facilities
  • Intellectual property (patents, brands)
  • Software

Hence, investment expenditures are usually non-recurrent and the assets that the company acquires are long-lasting. An investment in creating productive capacity in factory will not be needed to be done again for as long those assets last.

Costs

Costs are expenses that the company must incur on a regular a basis. It includes the consumables of a manufacturing process, the services that it acquires from third parties, the costs with human resources, taxes and fees.

In very simple terms, the investment is the car that one buys to go from one place to another. The fuel, insurance and maintenance are the costs that one person needs to incur to get the car running properly.

In your feasibility analysis

If you are unexperienced with feasibility analysis it can be easy to confuse and end up putting investment as costs or costs as investment. Be careful about not getting it wrong as the outcome can be different from reality.

Example

You are making a business plan. Your investment items are 6.000 EUR. Your estimated yearly costs are 4.000 EUR. Your expected yearly revenue is 8.000 EUR. If you put investment and costs together and the addition of those items is 10.000 EUR. You would reach the conclusion that your net profit is -2.000 EUR.

Year 1 Year 2 Year 3 Year 4
Revenue 8.000 8.000 8.000 8.000
Investment and costs together 10.000 10.000 10.000 10.000
Net profit -2.000 -2.000 -2.000 -2.000

That conclusion is incorrect. The correct analysis is:

Year 1 Year 2 Year 3 Year 4
Revenue 8.000 8.000 8.000 8.000
Costs 4.000 4.000 4.000 4.000
Net profit 4.000 4.000 4.000 4.000

And the investment would be only 6.000 in the first year. More while on the first case it seems you would always be losing money, on the following the investment would be recovered by the mid-second year (as the accumulated net profit would around 8.000 by the end of the second year).

So, while doing your feasibility analysis be sure to not mix costs and investment. CASFLOAPP helps you out as the forms to state costs are clearly separated from the investment.