What are expenses in accounting?

Accounting expenses include a wide range of costs, including deductible expenses like rent, utility bills, employee salaries, office supplies, and even business travel expenses.

For startups and small businesses, accurate bookkeeping is crucial because every expenditure impacts your bottom line.

Accurately calculating your operating costs is necessary for all of your financial planning—from budgeting to profitability analysis to strategic decision-making using your income statementss.

Whether you’re a small startup or an established corporation, managing common and variable expenses is the key to allocating your resources wisely and navigating your financial statements.

Types of expenses in accounting

Categorizing your expenses is important for securing business tax deductions and creating financial transparency for stakeholders. Your finance team also depends on expense categorization to compile an accurate balance sheet.

The types of expenses in accounting include:

• Essential expenses: Essential expenses, including the cost of goods sold (COGS), form the financial backbone of business operations. Within this category, you'll find fixed expenses like rent, utilities, and taxes, plus professional fees, office supplies, licensing fees, raw materials, salaries, insurance premiums, and the direct expenditures associated with producing or purchasing goods for sale. Timely payment of these expenses, including the meticulous management of COGS, is vital, as they collectively provide the foundation upon which business continuity relies.
• Discretionary expenses: Unlike essential expenses, discretionary expenses offer a choice. These are costs that a company can decide to take on or not. Examples encompass marketing expenses, public relations initiatives, events, video production, freelance services, collateral materials like business cards and flyers, or gourmet coffee for the office coffee maker.
• Operating expenses (OPEX): The bulk of essential expenses typically fall under the umbrella of operating expenses. OPEX represents the costs incurred during the normal course of business activities. It encompasses rent, equipment, inventory, payroll, insurance, and research and development. While marketing expenses could also fit here, they’re not considered essential for business survival.
• Non-operating expenses: Any expense that doesn't align with the definition of an operating expense falls into the non-operating category. This includes interest payments on debt, inventory write-offs, legal settlements, and investment losses. Some non-operating expenses may not be immediately obvious, highlighting the importance of expense management software and clear expense guidelines for accurate categorization.

These four expense categories serve as cornerstones in the intricate framework of expense management and financial decision-making. They help businesses maintain fiscal health, optimize tax benefits, and make sure that every dollar spent aligns with strategic objectives.

How expenses are recorded

How expenses are recorded depends on which accounting system your company uses—either accrual basis or cash basis accounting.

With the accrual basis method, expenses are recorded when the legal obligation is fulfilled. This happens when goods are received or services are performed, regardless of when the actual payment is made. For instance, if a service is provided in April, even if payment is made in May, the expense is recorded in April to accurately match costs with revenues.

Conversely, cash accounting only recognizes expenses when the actual cash exchange occurs. Using the same example, a utility bill received in April but paid in May would be recorded as an expense in May, as that's when the cash outflow happens.

Accrual accounting adheres to the matching principle, making sure that profits for each accounting period accurately reflect the related expenses incurred in earning revenue during the same period.

Is expense an asset or a capital?

Expenses are the practical costs that businesses incur to function smoothly and drive revenue. They don't fall into the category of assets; instead, they are the necessary expenditures that either chip away at equity or add to liabilities.

However, there are instances where an expense can transcend its immediate deduction from revenue and become an asset or capital expenditure.

This transformation occurs when the expense is expected to provide future economic benefits beyond the current accounting period. For example, the cost of acquiring and installing a new computer system is initially recorded as a capital expenditure, representing an asset with future value. Over time, it’s gradually expensed through depreciation or amortization, aligning with the principle of matching expenses to the periods in which they contribute to revenue generation.

5 expense account challenges for small businesses

Here are some of the expense account challenges that businesses commonly face:

Variable cash flow

Small businesses often experience erratic cash flow patterns, making it challenging to create precise expense budgets. As a business owner, you may find yourself struggling to make payments on time, which can create tension with suppliers, lead to extra fees and interest charges, and incur additional costs.

Manual data entry

Despite technological advancements, many small businesses continue to rely on manual processes for tracking expenses and entering data. This manual approach isn't only time-consuming, but also susceptible to errors such as double-entry, making it difficult to maintain precise financial records and reconcile accounts. Automated expense tracking clears up the possibility of human error while also letting you track expenses in real-time.

Expense policy compliance

Establishing and enforcing a clear expense policy can be challenging for a small business. Without a comprehensive policy in place, employees may make unauthorized purchases. This can lead to overspending, out-of-policy reimbursements, and a lack of transparency in financial reporting.

Receipt management

Keeping track of receipts and documentation for expenses can be cumbersome. In a paper-based system, receipts can be easily lost or damaged, making it difficult to verify expenses and claim tax deductions. In a digital world, managing electronic receipts and making sure they’re correctly categorized poses its own set of challenges, especially if employees use different tools and formats.

Scalability

As small businesses grow, their expense management needs evolve. However, adapting and scaling expense management systems can be tricky. Existing processes and tools may become inadequate, but transitioning to more sophisticated solutions can be costly and require significant training.

Small businesses that invest in streamlined expense management systems, enforce clear expense policies, and maintain robust financial discipline can overcome these hurdles and position themselves for sustainable growth.

Simplify and streamline expense management with Ramp

Ramp’s all-in-one corporate card and expense management platform is designed to streamline your business finances. Here are some of the ways Ramp can simplify your business expenses:

• Enforce your expense policy: Define clear rules and categories for business expenses, so only those transactions go through.
• Unlimited employee cards: Assign unlimited free virtual and physical employee cards with custom spending limits and vendor or category rules.
• Categorize expenses automatically: Ramp automatically logs and categorizes expenses every time you or your employees make a purchase, removing manual data entry.
• Generate expense reports: Ramp also integrates with bookkeeping and accounting platforms to automatically generate your expense reports.

Looking to make expense management easier? Explore more with our interactive demo.