ifp_3_The_Income_and_Expense_Statement_and_the_Cashflow_Statement.pdf

8/11/2019 ifp_3_The_Income_and_Expense_Statement_and_the_Cashflow_Statement.pdf

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18 Financial Planning Handbook PDP

Chapter 3


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19Financial Planning HandbookPDP

The Income and Expense Statement and

the Cashflow Statement

Your Income and Expense Statement reports income earned and spent during a specified period,while the Cashflow Statement presents a record of all the cash inflows and outflows during a particulartime period.

The difference between the two is that the cashflow statement records only the actual cash inflows and

outflows. It does not include amounts spent or earned on credit. On the other hand the income and

expense statement records all types of income and expenses.

These statements make it easy to see where your money is being spent. Many people complain thatthey earn large sums of money, but they never have anything left over. Recording their expenditures is

a first step to taking control of their financial affairs. Because earnings and living expenses also influence

net worth, these statements also show that change.

The income statement shows actual income and expenditures over a period of time, whereas a balance

sheet or Statement of Net Worth shows financial position at a single point in time.

There are three steps to creating an income statement, as shown in Worksheet 3.1.

List all income received during the time period.

List all expenditures made during the time period.

Determine the surplus/deficit of income over expenditures.

Step 1: List All Sources of Income

List all sources of income for the period of the income statement. Income from salary is generally

received after deducting tax at source (TDS).

The main source of income for most people comes in the form of salaries, wages, self-employment

income, and commissions. Other sources of income include bonuses, interest, dividends, rent, gain on

the sale of assets, and gifts and inheritances. All sources of income should be included in order to make

the income statement complete and accurate.

Step 2: List All Expenditures

Expenditures show where cash flows have been spent. Major categories of expenditures should be listed. It

is not necessary to account for every penny spent. By reviewing cheque-book records and credit card statements

and recording the cash payments, you can easily develop categories of expenditures. By adding the payments

made in each category, you will have a fairly accurate account of where your money has gone.

Certain expenditures are fixed; that is, they remain the same each month or year. Examples of such

expenses are rent, mortgage payments, life insurance premiums, and equated monthly instalments of

loans. These are called Fixed expenditures.


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Certain expenses change from month to month, such as food, clothing, medical expenses; telephone

and utility payments; household operating expenses; contributions; and recreational expenses. These

are called Variable expenditures.

Both Fixed and Variable expenses can be either Discretionary or Non-Discretionary Expenses.

Discretionary Expenses: Eating outside, Excess Consumarisation, Changing models of mobile every 3months etc.

Non-Discretionary Expenses: House Maintenance Charges, Grocery Expenses, Medical Expenses,

Electricity Charges where you cannot really do any curtailments.

Step 3: Determine whether there is a Surplus or Deficit of Net Cash Flow

When income exceeds expenditures, there is a surplus. When expenditures exceed income, there is a

deficit. Funds to cover a deficit can come from withdrawal from savings or by taking a loan, both of which

decrease net worth.

A surplus represents an increase to net worth if the amount is used to increase savings, invest it wisely

to acquire additional assets, and/or pay off debt.

Note:

Cash surplus increases net worth while a deficit decreases it.


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21Financial Planning HandbookPDP

What can the Income and Expense Statement/Cashflow Statement tell you?

The income and expense statement is an important tool which helps in understanding current spending

patterns and formulating a budget.

If your expenses exceed your income, you have a negative bottom line or a "net loss." That is, you are

depleting your net worth, a situation that sometimes requires prompt attention. If you have a substantial

surplus, it means that your net worth is growing.

You can divide total expenses by total income to learn what percent of income you are spending into

Discretionary and Non Discretionary Expenses. This shall give the indication of what amount is utilized

and what amount is being wasted. Compare this to previous periods to learn if your ability to grow your net

worth is improving.

Income is difficult to increase in the short term. Longer-term income can be increased by establishing

yourself in your profession, finding a better-paying job, or changing careers. The latter alternative should

be deliberated carefully before any moves are made.

Expenditures are also difficult to reduce, but variable (Discretionary) expenditures are easier to cut than

(Non Discretionary)fixed expenditures. For example, it may be easier to reduce recreation, summervacation, and/or entertainment expenses than necessary living expenses, such as food, loan payments

and utility expenses.

By going through the process of compiling an income statement, you can see where money has been

spent and where you need to reduce expenditures, if necessary. The income statement is not only an

important tool in helping to understand current spending patterns, it also assists in formulating a budget.


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Chapter Review

Exercise

1. Anil lives in a flat, which he purchased 10 years ago for Rs. 10 Lakhs. There is a loan outstanding

for Rs. 3 Lakhs left. The monthly EMIs, which Anil pays towards the loan, is Rs. 4000 pm. His wife

has jewellery worth Rs. 2 Lakhs.He has a car, which he purchased for 3 Lakhs, four years ago. He

pays a monthly EMI of Rs. 2000 for his car loan. His life insurance and pension funds cost him Rs.4000 pm. He earns Rs. 40000 pm. His car requires petrol worth Rs. 3000 pm. The grocery bill adds

up to Rs. 8000 pm. His wife, Mina likes to eat out. They spend Rs. 2000 on entertainment every

month. His mobile bill and utilities come to Rs. 6000 pm. His credit card bill is Rs. 2000 pm.Anil

earns interest income up to Rs. 400 pm.He has no other source of income.

Prepare his income and expense statement. Is there a surplus or a deficit? State the discretionary

and non-discretionary income. What is the percentage of discretionary and non-discretionary expenses

to the income?

2. Mukesh, a student had withdrawn Rs.3000 on 1stMay07. By the 10thof May, he had only Rs. 100

in his wallet. Intrigued as to where he spent all his money, he decided that for the following month,

he would maintain a note of all his cash outflows and inflows.

One June 107, Mukesh withdrew Rs. 3000 from ICICI Bank. On the 1st, he had travel and eating

expenses of Rs. 150. On the 2nd, he bought some fruits worth Rs. 45 and had conveyance of Rs.

50. On the 4thand the 5th, he had miscellaneous expenses of Rs. 500. On the 7thof June, he realized

that the rains will start soon and that he needed both a pair of rainy shoe and a bag. He purchased

the office bag at Rs. 700 and the shoes cost him Rs.900. He hunted out his old umbrella that had

served him well for the last 2 rainy seasons.

How does Mukeshs cash inflow-outflow statement look like? Does Mukesh have a surplus or a

deficit? Is he better off in June than in May?

ifp_3_The_Income_and_Expense_Statement_and_the_Cashflow_Statement.pdf

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