You're more than likely familiar with expenses as they apply to our daily lives: we all deal with daily and monthly expenses like rent, food, clothing, furniture, transportation... the list goes on. And on. Similarly, when something costs a lot, we're quick to call it "expensive." But how do we talk about expenses in terms of accounting?
In accounting, an expense can be defined as a cost—an outflow of cash or other asset of value—incurred during a particular accounting period.
Before we go further, it may be helpful to revisit the good ol' accounting equation. (See also: What is an Accounting Transaction?) Quickly, the equation is assets = liabilities + owner's equity. This equation must remain balanced, otherwise something's gone wrong within an accounting system. When an expense happens, both the assets and owner's equity are decreased, and since these are on opposite sides of the equation, it remains in balance.
So what are some examples of expenses incurred in the normal course of running your business? Much like with personal finance, there are the obvious ones: rent, utilities, payroll, cost of goods sold, marketing, R&D, office supplies. Beyond the basics though, expenses will vary from business to business, industry to industry. So let's dig deeper...
Operating and Non-Operating Expenses
There are two main categories of business expenses in accounting: operating and non-operating.
Operating expenses relate to your company's main activities, and can be broken down by department, product line, etc., depending on the way your company is set up. For example, if you own a retail business, some of your operating expenses could include cost of goods sold, commissions paid to sales staff, and the cost of renting your retail space.
Non-operating expenses are those that are not directly related to your business' main activities. The most common non-operating expenses would be interest charges or other charges related to financing your business.
How are expenses recorded?
Expenses are generally recorded on an accrual basis. This means that on any given income statement, the expenses match up with the revenues reported for that accounting period, and not with the period during which you actually pay for these expenses.
A couple of simple examples should help clarify what that means. Let's say you're preparing your income statement for the month of October. If you're a retailer, you will be recording the cost of goods sold in October, even if you actually paid the cost of these goods during a different accounting period. Likewise, any utilities used in October (electricity, phones, etc.) will be part of October's income statement, even though you will likely be paying for these services during the following month.
Depending on the size and complexity of your business, you may have one or several expense accounts which are drawn from when expenses are incurred. Expense accounts are generally debited when an expense is recorded. (Not sure what this means? For an in-depth look at which accounts are normally debited and which ones are credited, and what exactly these terms mean, take a look at our recent post, What is a Debit and Credit in Accounting?). Essentially, when a debit occurs in one account, a credit must occur somewhere else to balance it out. In this case, the account credited may be Cash (if the expense is paid for right away), or Accounts Payable. (For a run-down of Accounts Payable, check out our post on Accounts Receivable vs Accounts Payable.)
Why is Tracking Expenses Important?
Expenses form a crucial part your income statement, which is one of the tools you can use to gauge your business' financial health, progress and tax obligations. You want to be able to make smart business decisions that help your company's profits grow, right?!?! Well, tracking expenses can help you identify hidden expense categories that you can eliminate—so long as they don't adversely impact your bottom line.
Learn how to enter expenses in Kashoo over at the Support Center: Entering Expenses, Bills and Bill Payments.
Have more questions? Drop us a line at email@example.com and we'd be happy to help! And stay tuned for our next blog post, where we tackle the question: What is net income?