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Both costs and investments result in spending money. Costs are spending money to run the business and investments are spending money to prepare for the future.
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Quick reference
Cost and Investments
Both costs and investments result in spending money. Costs are spending money to run the business and investments are spending money to prepare for the future.
When to Use Revenues and Profits
Companies must decide when and how to spend money in the business. The allocation of money for costs and investments are initially decided at budgeting time and the final decisions are made on an ongoing basis.
Instructions
- Both costs and investments spend money.
- Costs spend money to run the business.
- Money spent making products or services that are sold to customers.
- Money spent on salaries of employees who run business processes or manage the business resources.
- Money spent to pay bills from suppliers and contractors who are providing goods or services needed to run the day-to-day operation.
- The value of the cost transaction is the amount of the money to be spent. The time attribute for the cost transaction is recorded at the time when money changes hands in a cost-basis company. The time attribute for the cost transaction is recorded at the time when the invoice is received and the liability is incurred in an accrual-basis company.
- Investments spend money with the promise that the result of the spending will provide a specific future value to the company.
- Investments are a gamble by the company. The spending of the investment will consume money now; but there is a promise of benefits to the company in the future. Examples are the investment into new products, new systems, new facilities, or into research.
- Investments are treated differently on the basic financial reports than other costs. The method for how they are treated is explained in those modules.
- Investments are normally analysed in advance to determine if the projected benefit is adequate given the amount of investment money spent.
- Benefits can be new revenue, lower costs, or cost avoidance or future projected costs.
Hints and Tips
- When determining investments, include finance in the discussion since they must record these differently than operational costs.
- Investments are often discretionary – you can defer spending that money and stay in business. Operating costs are mandatory – if you don’t spend them you can’t stay in business and deliver products and services.
- 00:04 Hi, this is Ray Sheen.
- 00:06 Let's talk about how expenses are treated.
- 00:08 In particular, the difference between cost and investment within a business.
- 00:13 Let's start with a discussion of costs.
- 00:17 Cost is the money that is spent by the business to run the business.
- 00:22 It is money spent to make products, to pay salaries of the employees,
- 00:26 to pay the bills from suppliers.
- 00:28 When you think about what it takes to run a business,
- 00:30 you are normally thinking about costs.
- 00:33 Remember that every financial transaction has two components, an amount and a time.
- 00:39 In a cash based business, the time for cost occurs when the money changes hands.
- 00:43 In an accrual based business, the time for cost occurs when the liability
- 00:47 is incurred even though the bill may not be paid for many days or weeks.
- 00:52 Now let's contrast costs with investments.
- 00:55 Investments are money that is spent in order to create a future benefit or value.
- 01:00 There are special rules for what is considered to be an investment.
- 01:05 These rules depend upon the category of spending, the amount of spending, and
- 01:09 the tax laws of the country where the spending occurs.
- 01:13 Investment spending is spending money with a promise of making money.
- 01:18 However, the time of spending money and the time of the benefit, or
- 01:21 making money, are typically two different time periods.
- 01:24 So the amount of money that is available now is reduced.
- 01:28 And the amount of money that will be available later will be increased.
- 01:32 If the increase is large enough and
- 01:34 the business can afford it now, this is sound business practice.
- 01:39 But since this money is spent with a promise attached to it,
- 01:42 it is tracked differently on the various financial reports.
- 01:45 I will talk about the financial reports and
- 01:47 how to track the different types of spending in detail in other modules.
- 01:50 I would now like to discuss a few of the differences between costs and investments.
- 01:56 Both spend money but it's for different purposes.
- 01:59 Investments are a special category of spending.
- 02:02 It generally is discretionary spending that carries the promise of
- 02:05 future benefit.
- 02:06 Investments are treated differently in all three of the primary financial reports.
- 02:11 The earnings statement often splits the investment expenses and
- 02:14 spreads it over the benefit period.
- 02:16 Using the concept of amortization and depreciation, the balance sheet
- 02:20 separates many of the investment expenses into a special category of fixed assets,
- 02:24 showing there's a promise in that spending.
- 02:26 And the cash flow statement has one of its three categories devoted to
- 02:30 only investment spending.
- 02:32 Contrast this with the cost category of spending.
- 02:35 These costs are always recorded in the period of the transaction.
- 02:38 They do not add value to the balance sheet, and
- 02:41 they have their own separate categories in the cash flow statement.
- 02:45 Much of the complexity in the accounting standards and
- 02:48 rules is based upon how investment spending and
- 02:50 its corresponding benefit, is treated in various business conditions.
- 02:55 Typically as operational managers,
- 02:56 we don't need to know the details of how the accounting works.
- 03:00 We just need to know if something is an investment or an operational cost, so
- 03:04 it ends up in the correct category.
- 03:07 Operational costs are always accounted for in the current period.
- 03:10 Investment spending is accounted for
- 03:11 differently on different reports as I have already mentioned.
- 03:14 In some reports, it is a current period and in others it is future periods.
- 03:18 Again, this will be explained in more detail in the modules on financial
- 03:22 reports.
- 03:23 A special case of operational costs
- 03:26 will arise when an investment benefit is never realized.
- 03:29 If the investment expense has not been fully recorded,
- 03:32 the remaining expense will be converted to operational cost.
- 03:36 Eventually, the financial reports must account for all the spending.
- 03:42 Costs and investments are both forms of business spending.
- 03:46 As an operation manager, you must know the difference and record them properly so
- 03:51 that they will be accounted for correctly in the financial reports.
- 03:54 The rules for categorizing an expense as an investment
- 03:57 vary with the type of cost and the country you're in.
- 04:01 Work with your local finance person to properly categorize your expenses.
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