An expense is a cost necessary for running a business. As a company makes revenue, it incurs expenses related to its operations.
Why are expenses important for businesses?
Businesses use expenses to figure out net income and profit. To earn an income, a business must spend money, so managing expenses well is central to good financial health.
If your expenses are too high, your business’s viability might be at risk. If they’re too low, you could lose service quality. Having good expense-management principles will keep you financially stable and set you up for long-term success.
What are the main types of expenses?
Expenses are generally categorised as operating or nonoperating expenses, and as fixed or variable expenses:
- Operating expenses (OpEx): Costs directly related to a company’s main activities, like office supplies, rent, salaries and utilities.
- Capital expenses (CapEx): Money spent on long-term assets like property, vehicles and equipment, which are then written off over several years through depreciation.
- Fixed expenses: Regular, predictable costs that stay stable over time – think rent, salaries, insurance, etc.
- Variable expenses: Costs that fluctuate month to month, like raw materials, labour and variable-rate loan repayments.
- Non-operating expenses: Costs not directly related to the company’s core operations, such as interest on loans.
Some costs are semi-variable expenses, with both a fixed base cost and a variable component. Other expenses like emergency, essential, and discretionary costs also have an impact on your finances.
Essential expenses are necessary for business survival. Work-related expenses are costs incurred for employment (i.e. a uniform or home office utilities), which are kept separate from personal spending. A salary paid to staff is a fixed operating expense.
What are operating expenses?
Operating expenses are costs directly related to the day-to-day running of your business, including rent, salaries, utilities, marketing, and maintenance.
Cost of goods sold (COGS) is not an operating expense. COGS is a cost of producing goods, while OpEx is an indirect cost. Both bring down your net income on the income statement.
What are capital expenses?
CapEx is spent on purchasing or improving a capital asset like property or equipment. Businesses use capital expenditures to stay afloat and keep hitting their long-term targets over more than 12 months.
Let’s say a factory owner buys machinery to increase production. Unlike operating expenses, capital expenses appear on the balance sheet and are written off over several years, not in a single accounting period.
How are expenses recorded: Cash basis vs accrual basis?
Expenses can be recorded on a cash or accrual basis. Your choice will influence when the cost appears in your financial reporting.
Under cash basis accounting, expenses are recorded when they’re paid. For accrual basis accounting, expenses are recorded when they’re incurred. Accrual basis matches expenses with the revenues reported in the same accounting period, which might give you a better view of your finances.
As an example, when a business gets a tax invoice for rent, cash basis records the expense only when the funds leave the account. Accrual basis records it as soon as the invoice arrives.
Are business expenses tax deductible?
Plenty of business expenses are tax deductible. To claim a deduction, the expense has to be ‘ordinary and necessary’, paid or incurred during the year, and related to carrying on a business.
The ATO says you can only deduct expenses related to day-to-day operating expenses, the purchase of goods and services for your business, or capital expenditures (If they qualify under the instant asset write-off scheme). Not all expenses qualify.
Some of the more common deductible business expenses include rent, utilities, wages, maintenance, depreciation, and COGS. Make sure you keep all your tax receipts for at least five years.
What is expense management?
Essentially, it’s the process of tracking and optimising expenses to support your business’s financial stability and ongoing growth.
Good expense management can help you catch areas of overspending, as well as inefficiencies and potential cost savings. It keeps you compliant with financial regulations and improves your transparency in financial reporting.
Closely monitoring your expenses will also improve your ability to invest and adapt to changing markets. So it’s a good idea to carry out monthly reviews of transactions, as you’ll be able to make any necessary budgeting adjustments.
How can you automate expense management?
Automated expense management systems cut down on time costs, mistakes, fraud, and more. An expense report can be created, submitted, approved, and reimbursed automatically.
Expense reporting software syncs with accounting systems to streamline financial processes. Automated tools like banking apps help categorise spending habits, whereas budgeting apps track expenses by syncing up with bank accounts.
Think about using expense management software to record and categorise all your costs, which will keep your record-keeping accurate for tax purposes and give you more insights into your spending.
What budgeting methods help control expenses?
Zero-based budgeting assigns every dollar to a specific category to control cash flow. Alternatively, the 50/30/20 rule allocates 50% of income for necessities, 30% for wants, and 20% for savings or debt.
Building an emergency fund aims for three to six months of living expenses to cover the unexpected costs life can throw at you. And automating savings involves setting up automatic transfers on payday, so you’re not tempted to spend what you can’t see.
See related terms:
What is a ledger?
What is cash flow?
What are fixed assets?
