Income Statement for a Sole Proprietorship

As a sole proprietor operating in Switzerland, you may wonder whether it is necessary to prepare an income statement. While you may not be obliged to maintain detailed accounts, it is still essential to have a clear understanding of your business’s financial health and to keep accurate records of income for tax purposes. An income statement will help you fulfil both these needs. In this article, we will explore the importance of an income statement for a sole proprietorship and the different methods of producing and presenting them.

What is an Income Statement?

An income statement, also known as a profit and loss account, is a financial statement that summarises a business’s income and expenses over a specific period. It provides a detailed account of a company’s financial performance during that period and is an important tool for measuring profitability.

In Switzerland, income statements are commonly referred to as “Gewinn- und Verlustrechnung” (profit and loss account) or “Erfolgsrechnung” (income statement). The income statement is one of the three major financial statements alongside the Balance Sheet and Cashflow Statement.

What is the Purpose of an Income Statement?

The primary purpose of an income statement is to track the financial performance of a company over a specific period.

As an entrepreneur with your own sole proprietorship, it is not enough to gauge your success simply by looking at your bank balance. This merely gives you a snapshot of your financial position and does not clearly show you whether your business activities have led to a profit or loss over a period of time, and also the factors which contributed to your success or failure. This is where an income statement is a must, as it can provide a detailed picture of how successful your business has been and where that success (or failure) came from.

An income statements also serves many other practical purposes:

• It helps a company’s owners/managers accurately track income and expenditure and therefore make better decisions and plans based on this information,
• It provides detailed financial information for external stakeholders such as investors, lenders, and auditors, to assess and review the company’s profitability (less relevant for sole proprietorships),
• It can be used to calculate key financial metrics such as gross margin, net profit margin, and return on investment,
• It is needed for accurately calculating and declaring taxable income to the tax authorities.

Do Sole Proprietorships Need an Income Statement?

Not all sole proprietorships are legally required to maintain full accounting records in Switzerland. However, all sole proprietors must declare their income for tax purposes, which makes it necessary to keep a record of their income and expenses. Depending on your annual turnover, it may be acceptable to keep such records with simplified bookkeeping methods.

An income statement also serves many other useful purposes, so even sole proprietors who are not obliged to maintain a proper income statement are advised to do so for their own benefit.

Accounting Rules for Sole Proprietorships in Switzerland

As a sole proprietor operating in Switzerland, the specific accounting rules which you must follow depends in large on your annual turnover:

1. Sole proprietorship with an annual turnover of less than CHF 100,000

If you operate as a sole proprietor in Switzerland with an annual turnover of less than CHF 100,000, you are not legally obligated to maintain full accounts, nor are you required to register for VAT. However, you will still have to declare your income, and so you will need to keep an accurate record of your income and expenses. You may keep these records using whatever method works best for you.

2. Sole proprietorship with an annual turnover between CHF 100,000 and CHF 500,000

If you operate as a sole proprietor in Switzerland and have an annual turnover of more than CHF 100,000, you will be required to register with the Commercial Register. In this case, formal bookkeeping is mandatory. You will also have to register for, and pay, VAT.

If your annual turnover remains less the CHF 500,000, you are allowed to use simplified, single-entry accounting. The basic requirements are that your books must:

• Include income and expenditure accounts, recorded in chronological order.
• Record any changes to your assets and liabilities.
• Include deductions for VAT.

3. Sole proprietorship with an annual turnover greater than CHF 500,000

Sole proprietorships in Switzerland with an annual turnover exceeding CHF 500,000 are required to use double-entry accounting which complies with the accounting principles set forth in the Swiss Code of Obligations (CO). This would necessarily include full financial statements which means maintaining a balance sheet, Notes to the accounts, and, of course, the income statement (profit and loss account). Other important principles such as time-deferrals must also be followed.

A more in-depth discussion about double-entry accounting can be found here.

Methods of Producing and Presenting the Income Statement

Income statements can be produced with different methods and presented in various forms. We will discuss the most common methods of producing and presenting income statements and compare the differences between them.

Single-Step vs Multi-Step Income Statement

Small businesses and sole proprietorships have the option of preparing their income statement using a single-step or multi-step approach. Both types of income statements contain information on the business’ revenues, expenses, and profit or loss during the accounting period, but differ in the level of detail and complexity involved.

Single-Step Income Statement

A single-step income statement is a simpler approach to reporting a business’ revenue, expenses, and profit/loss. It calculates the profit or loss through a single, simple equation:

Net Income = (gains + revenue) – (losses + expenses)

A single-step income statement involves a simple accounting method and is, therefore, easy to prepare and understand. It does not have a high level of detail and so is usually better for smaller companies and sole proprietors who just need to make a basic assessment of their net income.

A single-step income statement is best suited for you if:

• You only require a simple report of the net income of your business,
• You don’t not have complex or large-scale operations,
• You don’t wish to separate non-operating expenses from operating expenses and cost of sales on the income statement.

A single-step income statement is not the right choice if you need a more in-depth analysis of your business’ profitability and financial health. In this case, merely looking at the net income is not sufficient to be able to assess your business’ financial performance in detail. For most sole proprietors, a single-step approach to the income statement is sufficient.

Multi-Step Income Statement

A multi-step income statement uses a three-step process (or three accounting equations) to calculate a company’s net income. It also separates operating revenue and expenses from non-operating revenue and expenses, which provides a more informative view of a company’s net income and where it came from.

A multi-step income statement uses the following three formulas to calculate a company’s net income:

1. Gross profit = sales revenue – cost of goods sold
2. Operating income (or loss) = gross profit – operating expenses
3. Net income (or loss) = operating income + non-operating income (net of non-operating revenue – non-operating expenses)

A multi-step income statement is more complex to prepare, but it offers a greater level of detail, and provides a breakdown of expenses and revenue according to operational and non-operational items. This is useful for larger companies who need a more in-depth analysis of their income statement and have the capacity to cover the extra cost and complexity that comes with using this method. It is also necessary if you need to report on gross profit and/or operating income. Generally, such metrics are not strictly required for sole proprietors, but can still be useful information for those who desire it.

Production vs Sales Income Statement

In addition to being able to choose between a single- and multi-step approach to calculating your net income with your income statement, you also have some freedom over how to present your income statement. The two most popular ways of presenting the income statement are the production income statement (nature of expenses method) and the sales income statement (cost of sales method).

Production Income Statement (Nature of Expenses Method)

The nature of expenses method involves grouping expenses according to the type of expense they fall under, such as salaries, rent, raw materials, etc. The income statement will then show the total expenses incurred for each expense category. This method is relatively simple and it does not include any information on what the expense is to be used for (i.e., its “function”), nor does it distinguish expenses incurred in different departments or on different product lines.

As the nature of expenses contains less detailed information and does not separate expenses by function (e.g., operating vs non-operating expenses), it is usually the preferred choice for single-step income statements. Its simplicity and ease of use make it best suited for the self-employed and small businesses and would therefore be appropriate for most sole proprietorships.

Sales Income Statement (Cost of Sales Method)

The cost of sales method involves grouping expenses according to their function or purpose (e.g., the products or services they relate to, which department they were for, etc.). The income statement will then show the cost of sales for each according to these categories.

Examples of expense items in a sales income statement include:

• Administrative expenses,
• Research and development expenses,
• Cost of goods sold,
• Sales and distribution costs,
• Financing costs, etc.

This easily allows separation according to operating and non-operating expenses and revenue and is therefore the preferred choice in the preparation of a multi-step income statement. It also provides useful additional information about which areas of business resulted in expenditures and revenues. The cost of sales method is generally preferred by large and medium sized businesses, especially those with multiple stakeholders who require more detailed information about the performance of the company.