What are expenses?
An expense is a cost experienced by a business to generate revenue.
Expenses include salaries given to employees, advertisement costs, tax expenses, insurance, water and electricity, stationery, fuel, and any other items, activities or assets that can be classified as necessary for running your business.
All expenses incurred by a business during a particular accounting period are treated as a cost and recorded in an income statement. An income statement is often known as the Profit & Loss, or (P&L) Statement. It’s important to have a basic understanding of the three main financial statements to help you evaluate your company’s fiscal performance.
Note: Some business expenses can be deducted from your company’s revenue before they are subject to taxes. We’ll discuss this in detail in the later sections.
Now that we know what expenses are, let’s dig deeper into the different types of expenses that a business can incur.
What are the different types of expenses?
There are three major types of business expenses:
Operating expenses
Non-operating expenses
Capital expenses
Let’s look at each one of them in detail.
1. Operating expenses
These are the expenses incurred by a business in its day-to-day operations.
Operating expenses are short-term, recurring costs that are often paid off within the same accounting period that they are incurred in. An accounting period is usually the same length as your business’s financial year.
Operating Expenses (OPEX) are divided into two parts:
Selling, General, and Administrative Expense (SG&A)
Cost of sales
SG&A expenses encompass everything that is not directly related to the costs of producing the items that your business sells. Examples of SG&A expenses are paying rent or utility bills.
Cost of sales, on the other hand, are directly related to the cost of producing a company’s goods or services. For example, the materials your business uses to sell coffee, like cups or lids, would be calculated as part of your cost of sales.
Operating expenses and cost of sales are both included in the income or P&L statement, but are displayed as separate line items.
Let’s look at each type of operating expense in detail.
OPEX under SG&A expenses
Operating expenses under SG&A (Selling, General, and Administrative Expense) are normally associated with a company’s overheads.
Here are some operating expenses that fall under SG&A:
1. Utility expenses
These are expenses related to paying your utility bills.
Utility expenses include water, gas, and electricity that is consumed by your business on a daily basis.
2. Office supplies expenses
These expenses are incurred for the purpose of purchasing office supplies, such as stationery, tables, chairs, and printing supplies.
3. Telephone expenses
These are costs your business incurs when using either landline or mobile phones. These expenses are usually paid at the end of each month.
4. Travelling expenses
These include costs incurred by yourself or your staff when travelling for official visits, meetings, and related purposes.
These expenses may be infrequent, but when they do occur, they must be recorded in the income statement as traveling expenses.
5. Legal expenses
These are expenses incurred for using any kind of legal services.
6. Insurance expenses
These are expenses for purchasing general insurance, healthcare insurance, or fire insurance for your employees.
7. Advertising expenses
These are related to the promotion and advertising of your brand or your brand’s products.
Advertising expenses are part of OPEX (Operating Expenses) because they are incurred with the intention to increase sales or generate more revenue.
8. Bank charges
These expenses include fees or any other amount a bank may charge for transactions carried out by your business. For example, charges applicable to cheque processing.
OPEX under cost of sales
Operating expenses under cost of sales include all costs directly associated with the production of goods or services sold by your business during a specific time period.
Here are some operating expenses that fall under cost of sales:
1. Freight-in costs
This is the shipping cost that has to be paid by the buyer upon purchase of merchandise. Any expenses related to freight-in are considered as part of the cost of merchandise.
In case the merchandise has not yet been sold, then the same should be considered as part of the inventory.
2. Freight-out costs
This includes the transportation cost of merchandise. It is associated with the delivery of goods from the supplier to the customer.
3. Rental costs
This is the cost incurred for the use of rented property or machinery that provides support to production-related functions and operations.
4. Product costs
This is the cost incurred to make a single unit of a product to be sold to customers. This includes costs related to direct labor, direct overheads, and direct material.
5. Depreciation expenses
Depreciation is the reduction in the value of an asset due to wear and tear.
This may or may not be applicable depending on certain items used at the time of production.
2. Non-operating expenses
These are expenses incurred by your company that do not relate to the core operations of your business.
On the income statement, non-operating expenses are displayed after operating expenses and are deducted from the operating profit.
Here are some examples of non-operating expenses incurred by a business.
1. Interest expenses
The interest expense is the cost of borrowing money. It is the amount charged by a lender to a business for using the lender’s money.
This type of expense could include the cost of bank loans, bonds, convertible debt, and borrowed money from other sources.
2. Loss on disposal of assets
This type of expense is incurred when your business eliminates an asset from its accounting records.
The gain or loss that occurs upon disposal of an asset is calculated as the net disposal proceeds, minus the asset’s carrying value.
3. Obsolete inventory charges
These expenses refer to the inventory that’s at the end of its product life cycle. This inventory has not been sold, or has been unused for a long period of time, and is not expected to be sold in the near future.
This type of inventory can cause large losses for a company as its essentially dead weight.
4. Lawsuit settlement expenses
These are expenses involved in settling lawsuits.
Since these are not directly tied to the core operations of a company, they fall under the non-operating expenses category.
5. Restructuring expenses
This is the cost incurred due to reorganising business operations to improve overall efficiency and long-term profit.
Top Tip: Both operating and non-operating expense categories are generally recorded on an accrual basis. Accrual basis is a method of recording accounting transactions where expenses are matched with the revenues reported for a particular accounting period, and not with the period during which you actually pay for these expenses. Learn more about accounting fundamentals in our accounting for startups guide.