Personal Finance Beginner

What are expenses?

expenses

Key Takeaways

  • An expense is the cost incurred to do something—whether that is leading a certain lifestyle or running a business.
  • Business expenses can be broadly classified into operational expenses and non-operational expenses, while personal expenses can be thought of as mandatory or optional.
  • In business, expenses are the costs incurred to earn revenues, and expenditure is the money spent to purchase or grow fixed assets.

We all have expenses, and we love to talk about how we have too many. But only some of us really know how to manage them well.

Understanding expenses and learning to factor them in while planning can mean the difference between being broke and having a solid budget. So, which side do you want to be on? If your response is “Obviously, I want a solid budget,” you may want to stick around while we take a closer look at this concept.

What are expenses?

There are accountants who can help you manage your money these days. But it is still important to understand the basics of expenses.

The Oxford dictionary defines the term as “the cost incurred in or required for something.” In simpler terms, the money that a person or business spends to do something is what we call an expense.

For individuals, expenses usually mean the cost of personal or family living, like food, rent, services, or consumables. On the organizational level, they are the cost of doing business. The type of business will determine the costs incurred.

While individuals and businesses incur different types of expenses, the end goal is the same for both: to keep things running.

Types of expenses

There are several types of expenses that we all incur. They vary depending on the type of person or business we are talking about.

The costs incurred at the personal level can be classified as mandatory or optional. Mandatory expenses can include anything from food and travel costs to services we need for work today like the internet. Optional expenses are usually luxury items, the cost of eating out, and so on. In addition, one may also need to factor in expenses like loan repayments, and this article should help you do it.

The most common way to categorize the concept in the business context is as follows.

1. Operating costs

Often abbreviated as OPEX, an operating expense is an expense a business incurs as part of its normal business operations.

This type of expense includes pay for employees, consultants, and vendors, rent or mortgage, insurance, vehicles for the business, and costs of software, staff training and development, marketing and advertising, and maintenance. The operating expenses involved usually depend on the size of the business and the amenities and privileges given to the employees.

While managing their finances, businesses must provide favorable working conditions and maintain the quality of operations. Identifying which expenses are essential for its operations is a big part of striking the right balance.

After you identify what the operating expenses are, you could further divide them into two categories.

  • Fixed cost: A fixed cost is an expense that remains the same or recurs, irrespective of whether or not the business registers growth. Examples include rent, property tax, insurance, etc. A company also commonly tracks depreciation as an indirect expense.
  • Variable cost: A variable cost, unlike fixed expenses, is an expense that an organization incurs based on how much a business produces and sells. As a business increases its production and output volume, the variable expenses also increase. The converse is also true. Some common variable expenses are labor costs, cost of raw materials, utility expenses, and so on.

2. Non-operating costs

Non-operational expenses refer to any costs that aren’t directly related to the business’s main operations. They can include any number of things such as losses from investments, lawsuit settlement costs, restructuring or relocation costs, currency fluctuation, natural disasters, and so on.

A “one-off” cost is an expense of this variety. It is, therefore, handled discreetly. Generally, a firm won’t incur the same non-operating costs on a regular basis.

What are expenses in accounting?

While calculating your expenses, breaking them down into the categories listed above will help. Using the categories will help you ensure that you aren’t missing anything.

To account for expenses, you could use an income statement. You will need to factor in expenses to calculate your net income. After calculating your expenses, to arrive at net income, deduct the expenses from your income or business revenue. The formula below sums it up.

Net Income = Revenue – Expenses

Keeping track of costs can also help you lessen your tax burden because some of them are tax-deductible. Businesses, too, don’t have to pay taxes for some expenses.

Whether an expense is taxable differs from country to country. In India, all businesses must abide by the Internal Revenue Service. Some common tax-deductible business expenses are staff salaries and bonuses, rent or mortgage, maintenance and repairs, and business vehicles.

Differentiating between expenses and expenditure

In everyday speech, we tend to use the terms expenses and expenditure interchangeably. But in accounting, they have entirely different meanings. The costs associated with earning revenue are called expenses. Expenditure, on the other hand, is money spent on purchasing or growing fixed assets.

Both play different but valuable roles in the functioning of a business. They differ in terms of the following aspects:

1. Purpose: Expenses are incurred for daily functioning. On the other hand, the money that goes into establishing a business to get operations started is called expenditure.

2. Duration: The former is incurred on a short-term basis, while the latter is incurred for a long-term period.

3. Impact on the financial statement: Expenses impact profit and loss or financial statements as the costs incurred are taken from the revenue/income. Financial statements do not usually mention expenditures so they have little impact on them.

4. Frequency: Expenses are incurred at a particular frequency. Like salaries for businesses, or money for grocery shopping for individuals. On the other hand, expenditures generally occur once in the lifespan of a company. They include expenses incurred from repair and maintenance.

5. Expectation: Because expenses are frequent, they can be anticipated. In that, too, they are unlike expenditure.

6. Examples: Examples of expenses include salary, rent, and so on. Payments made to purchase new land or buildings for business, or equipment, for instance, are expenditures.

Conclusion

No two people with the same salary will have the same expenses. This applies to business too. The key is to set up a strong income statement and allocate the money to different types of expenses.

FAQs

What do you mean by expenses?

Expenses are the money spent in order to operate a business, household, or activity. They are the costs incurred through the normal course of business, personal life, or transactions and reduce profitability or add to the operating loss.

What is an example of an expense?

A common example of an expense is the money a business spends on renting office space, paying employees’ salaries, purchasing inventory, and other ongoing operational costs needed to run the business.

What are the 4 types of expenses?

The 4 main types of expenses are operating expenses like salaries and raw materials, interest expenses on loans, taxes owed on income, and depreciation representing decreasing asset values over time.

What are expenses called in accounting?

In accounting, expenses are costs that a business incurs through its operations to generate revenues. These costs show up on a business’s income statement and reduce its net income for the accounting period when the expenses are recognized.

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