Understanding Business Expenses from All Angles

Understanding Business Expenses from All Angles-sm

Business expenses are part of the entrepreneur’s learning curve. When you’re first getting started, you might wonder—among many other questions—“What are business expenses?” You may have heard that tracking your expenses can help you manage your business’ finances in the long run. 

Still, a business expense is money out the door, which can in turn impact cash flow. Understanding business expenses isn’t just a matter of keeping receipts and a spreadsheet; it’s a key part of managing your business finances altogether. 

Let’s take a look at examples of business expenses and break them into categories, so you can begin to recognize them in your day-to-day operations.

Direct Costs vs. Indirect Costs

Before you consider business expenses from a tax perspective, it’s important to learn the terminology used in business income statements, including direct and indirect costs. Direct costs can include labor, supplies, and materials. These costs can go a long way toward helping you decide your pricing model, as they give a glimpse into what it costs you to produce your product or deliver your service. However, business owners often also consider indirect costs such as utilities, office supplies, rent, and any other overhead to support business operations. 

When recalling the difference between the two, remember that direct costs usually relate to your product or services, whereas indirect costs usually relate to your business. If you want to do a little advanced math for price modeling, you can calculate your overhead rate by adding up your overhead costs and dividing them by your gross sales revenue. This will tell you how much you spend in indirect costs for every dollar earned in sales. Becoming more attuned to your business finance can help you become a more dynamic business owner. That said, it’s always wise to consult an accountant or financial professional about your specific situation.

Recurring Costs vs. Non-Recurring Costs

Next, let’s get you caught up on the difference between recurring and non-recurring expenses. Recurring expenses are ongoing costs that occur in fixed intervals. Many indirect costs—rent, utilities, etc.—tend to be recurring expenses. Keep in mind that some direct costs, such as wages and salaries, are recurring, too.

Recurring costs are usually easier to track than non-recurring costs. That’s because non-recurring costs are one-time expenses that do not happen regularly. For example, if you purchase a point of sale system, you would not anticipate the same expense again in the foreseeable future. The need for a new point of sale system could certainly arise if yours breaks or becomes outdated, but you won’t budget for a new point of sale system every month or even every year. If your point of sale system includes a monthly software fee, however, that cost is recurring. 

Interest Is a Business Expense, Too

An income statement will typically list any interest payments before deducting the sum of direct costs, indirect costs, and interest to determine the business’ net profit or loss. For new entrepreneurs and small business owners, this section may be nominal to non-existent. This depends on your situation, however. Taking out a business loan, line of credit, commercial auto loan, or commercial mortgage, for example, may change your income statement. 

Deductible Expenses

What can you write off as a business expense? That will depend on your type of business. In general, the following business expenses may be tax deductible, meaning they can be subtracted from your gross revenue to reduce the amount of tax you owe.

  • Rent
  • Utilities
  • Equipment
  • Office supplies
  • Advertising and marketing
  • Wages and salaries
  • Employee benefits
  • Professional education
  • Training
  • Payroll fees
  • Business insurance
  • Business fees (licenses, permits, etc.)
  • Travel
  • Business vehicles
  • Legal fees
  • Loan payments
  • Interest payments
  • Professional services

That’s a long and advantageous list, but it’s not without nuances. For example, meals and entertainment are only 50% deductible, and this expense category has undergone several changes in recent years. Previously, the Tax Cuts and Jobs Act of 2017 eliminated or restricted many meal and entertainment deductions. Recently, the IRS issued newly proposed regulations. It gets confusing, which is why it’s always advisable to speak with a professional who can assist with getting your business expenses in line with IRS rules and requirements.

For your baseline knowledge, this guidance from the IRS can be helpful:

“To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.”

Read more from the IRS on deducting business expenses.

Non-Deductible Expenses

While many business expenses are deductible, some are not. Non-deductible business expenses can include:

  • Clothing
  • Gifts
  • Penalties
  • Fines
  • Political contributions
  • Lobbying
  • Minimum education to meet business requirements
  • Certain insurance

Non-deductible expenses can quickly become complex. For example, general liability insurance may be deductible, but disability insurance may not. If you are working from home and want to claim a home office deduction, how you define your home office must be very specific, exclusively used for work, and calculated as a percentage of your rent based on square footage in order for you to claim a home office deduction. Business gifts over $25 are non-deductible. Commuting solely from home to the office is non-deductible as well. You can see why we recommend time and time again to speak with a financial professional. 

3 Quick Tips for Tracking Your Expenses

Knowing business expenses in broad terms will give you a running start to keeping track of your expenses. Here are a few parting recommendations as you get started: 

  1. Leverage Technology

There are many expense tracking tools available. These allow you to digitize receipts, automate recurring costs, categorize expenses, and more. Digital banking can also assist with giving you greater visibility into your expenses and may even integrate with your accounting software.

  1. Be Consistent

Once you fall behind on logging expenses, it’s difficult to get caught up without potentially missing items. Whether it’s daily, weekly, or monthly, hold yourself to the responsibility of managing your expenses. Remember, many expenses are tax deductible, giving you the incentive to capture them to the fullest extent allowable by the IRS. 

  1. Streamline Payments 

For every expense, there’s a payment. Your efficiency in managing payments will go hand in hand with your ability to accurately track expenses.

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Hi there! This post exists to offer you (hopefully) useful information but it cannot take the place of personalized professional advice. Please consult a qualified expert if you have questions about your business. Also, Azlo doesn’t endorse any third-party sites that are linked here.

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