What Are Business Expenses? Definition, Types and Examples
Updated July 21, 2022
Every business needs to track its income and spending to measure profitability and to prepare financial documents. One of the important aspects of this tracking is expenses. Understanding what expenses are and how they work will help you organize financial records and allow you to better track the costs of a business. In this article, you will learn what expenses are, the different kinds of expenses and why they are important.
What are expenses?
Expenses are costs that are related to revenue generation. Basically, expenses are the money you spend while doing business. They are often paid periodically, as in the case of wages or monthly utility bills. While expenses and costs are terms often used interchangeably, expenses are tracked for the profit and loss statement and can impact taxes. Costs represent a broad category that refers to how much you spend on something, regardless of how it relates to generating income.
In accrual-based accounting, expenses are matched with a source of income on the financial statement. So, wages are recorded with the profits from the day the employee worked. This also means that the expenses are recorded when the expense happens, rather than when it is paid. For example, employee wages are recorded when the hours are worked, not when paychecks are cut, distributed to the employees or clear the employee's bank. Expenses are recorded under specific accounts in the accounting books—electricity, internet and water would be recorded under "Utilities."
Why are expenses important?
Here are some reasons why expenses are an important part of doing business:
You can track the costs of doing business. Because expenses are directly related to the revenue they generate, you can see how much you spend as you do business. This helps you lower costs, allocate resources and compare the cost of doing business over time.
You can see separate expenses by category. Since each expense is recorded under a category, you can see how much is spent on each category and how those costs change over time. This lets you prepare for an increase in wages during busy periods or increases in utility costs during winter or summer.
You can record expenses for taxes. Many expenses are tax-deductible. Tracking expenses allows you to easily find and report them during tax season.
You can control cost. You can see what expenses are unnecessary or can be decreased, which helps improve profitability.
You can quickly determine a company's profitability. Profitability is the difference between revenue and expenses. Having clearly, consistently recorded expenses lets you readily see how profitable a company is.
Types of expenses
Expenses are categorized based on how they relate to doing business and whether they change with the production of a product or service. It is important to understand how these expenses affect a business so that you can develop budgets and business plans. Different kinds of expenses are also reported differently on financial statements. Here are the four kinds of expenses:
Fixed expense: A fixed expense is a cost that does not change with the amount of production. This means that you will not pay a different amount if you sell more or less. A good example of a fixed expense is rent — you will pay the same amount for the space no matter how many products you sell.
Variable expense: A variable expense does change with the amount you produce or sell. For example, your electric bill will be higher if you are open more hours and you will pay more in commissions as your sales increase.
Operating expense: Operating expenses are those costs related to making a product or providing a service. These are the costs of machines, rent, utilities and wages.
Non-operating expense: Non-operating expenses are those costs that aren't related to how a business functions. They include any interest and taxes.
Related: Q&A: What Does a 'Fiscal Year' Mean?
Examples of expenses
Every business has expenses that are unique to the industry or company. For example, a manufacturer has different expense categories than a retailer because it transforms raw materials into a finished product and sells the result at wholesale value, rather than a finished product directly to a customer.
However, there are some expenses you can expect to see in every business. Here are some of the most common examples of expenses you might see on a balance sheet or profit and loss statement:
Cost of goods sold (COGS): These are all expenses directly related to producing a product or providing a service. It can include raw materials, direct labor, storage costs and factory overhead.
Selling, general and administrative (SG&A): These are all expenses not related to production. This category might include rent, advertising, litigation, marketing, management salaries and other expenses that are not directly related to a product or service.
Marketing, advertising and promotion: These are expenses dedicated to attracting customers and building a brand.
Salaries, benefits and wages: These expenses are for employees' salaries and benefits packages. Benefits might include health and vision insurance, bonuses, vacation time, educational reimbursement and 401(k) contribution matching.
Rent and insurance: These are expenses paid toward leasing a retail or warehouse space, as well as liability and automobile insurance.
Utilities: These expenses include water, sewage and garbage disposal, electricity and internet access.
Depreciation: This is an expense that shows how certain assets lose value over time. For example, machinery and equipment will wear down as you use them.
Interest: This is a non-operating expense that covers any interest paid on loans, credit cards or lines of credit.
Taxes: This is a non-operating expense that includes any taxes paid for doing business. Some taxes include sales tax, employment taxes and state and federal business taxes.
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