Non-cash expenses explained and some common examples

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What are non-cash expenses?

An expense that does not include any exchange of a cash payment is a non-cash expense. These expenses are an integral part of an income statement. However, they do not impact cash inflows and outflows of a business. You can estimate these costs to better manage your operating cash flow. 

Cash expenses vs. non-cash expenses

What is the difference between a cash and non-cash expense? For a typical business, employee salaries (payroll), rent, interest expenses, supplies, marketing, employee benefits, insurance, and taxes are all examples of standard cash expenses.

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Cash expenses are often in exchange for services or goods that are essential to operate the business. These expenses result in cash outflow. As your company grows and recruits more employees, buys, or leases additional real estate, and needs more supplies, these will all account for higher cash expenses. 

Examples of non-cash expenses

Here is a list of common non-cash expenses your business might account for:

Depreciation

Depreciation is a reduction in asset value because of usage and wear and tear. Tangible assets will depreciate based on company policy and the nature of the asset. Standard depreciation duration is between three and seven years. 

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An example of a depreciation expense is buying a new shipping truck for your business. Every year, the value of that truck depreciates from the initial purchase price, allowing you to account for the cost across the truck’s useful life.

Amortization

Amortization refers to writing down an intangible asset or a loan. An asset value is reduced over the life of a loan or an intangible asset which can usually range anywhere from six to fifteen years. 

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Let’s say you take out a $10,000 loan, and you pay $1,000 per year, you can account for the cost of $1,000 each year in, as opposed to the full cost of the loan all at once.

Stock-based compensation (SBC) 

Stock-based compensation (SBC) is when you grant stock incentives to employees to hire and retain talent. SBC can be in the form of stock options, restricted stock units (RSUs), and employee stock purchase plans (ESPP) and part of the employee’s compensation package. 

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Each of the three strategies vary slightly, though they each qualify as a non-cash expense:

1. Stock options: You grant employee stock options that are exercisable in the future at a set price (strike price). If the value of the stocks rises above the strike price, the employee is “in the money” and will exercise the options. If the stock price of the company is lower than the strike price, you’re “out of the money”. You will not exercise the options and options become worthless in this scenario. 

2. RSUs: You grant restricted stock units to employees usually quarterly or annually as a part of an employee compensation package. Employees own the share on the vesting date. RSUS can then be sold in the public market for cash. 

3. ESPP Plans: You offer an ESPP plan where employees can purchase the company stock at a discount. This is recorded through regular payroll deductions. The shares are purchased by employees through after-tax deductions for a given pay period. 

Unrealized gains/losses

Unrealized gains and losses are usually referred to as not real or paper gains and losses. These amounts are not actual gains/losses because the asset has yet to be sold and you don’t have the actual cash. This item on the income statement captures the value of the asset quarterly to show the unrealized gain or loss for the asset held. 

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An example is ownership in a stock. You bought at a fixed price, and if that stock’s price increases or decreases, the gain or loss only really exists on paper until you sell it.

Bad debt expense

Bad debt is an estimate of funds you believe will never actually be collected. The estimate is recorded as a reduction to net income. These accounts are likely unrecoverable and will never convert to cash, even though revenue for these accounts is recorded on the books.

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For example, one of your regular customers owes you for a recent sale, but they suddenly go out of business. It’s not likely you will be able to collect off that invoice. Bad debt expense is often estimated as a percentage of sales or a percentage of receivables. 

Asset impairment

An asset impairment is when the market value of a fixed or intangible asset is less than the value listed on your balance sheet. This is different from depreciation, since depreciation is expected and you can plan for it. Asset impairment occurs due to changes in the market, new regulations, or other sometimes sudden circumstances.

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Let’s say your office space is damaged by flooding after a hurricane. You would record an asset impairment to lower the property value on your balance sheet. An example of a goodwill impairment is if you acquire a new company at a higher price than it may be worth on paper, but you allow for the impairment because you are confident the intangible value will make up for it.

Deferred taxes

Deferred tax liabilities record taxes that have not been paid yet, but will in the future. You could also have deferred tax assets, when you have overpaid for taxes and would like to use that overpayment to account for future tax payments.

How to account for non-cash expenses

As you learn to account for your non-cash expenses, your cash flow statement becomes an indispensable tool. This financial statement provides a detailed breakdown of:

• Cash inflows and outflows from operating
• Investing
• Financing activities

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It’s very important to record non-cash expenses. Understanding the impact of non-cash transactions and analyzing the cash flow statement can enable a company to achieve positive operating cash flow.

Examples of non-cash transactions

To get a better sense of how this works, let’s take a look at a summary of non-cash components of four Big Tech companies for 2023.

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As shown below the biggest non-cash expenses for big tech and startups are usually stock compensation expenses and amortization and depreciation. 

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As tech companies usually don’t need more physical space or assets for expansion, depreciation costs are likely to lower over time. 

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For large tech companies stock compensation expense is likely to increase over time as companies try to retain and hire top talent within key growth areas.  

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Below is a view of Microsoft and Amazon’s non-cash items-

(Source: 2023 10K filing)

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Non-cash expenses are critical to both income statements and operating cash flow. Certain non-cash expenses such as depreciation can reduce the company’s taxable and net income, thereby increasing the operating cash flow. 

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For companies in the early stages of scaling up, the ability to extract the value from non-cash expenses is crucial as it can help you strategically reinvest into new products, pipelines, opportunities, and employees.

How to evaluate non-cash expenses

Some companies, like tech startups, are not profitable in the early years. They typically achieve profitability in later stages. However, in those early stages, it’s critical to evaluate operating cash flows in addition to profitability. 

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Here are some key questions when evaluating your cash and non-cash expenditures:

• Is the company generating a positive cash flow? 
• Is net cash provided from operating activities increasing each year? 
• What is the impact of non-cash expenses year over year? 
• How is the company managing non-cash vs. cash expenses and reinvesting in the business? 

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The answers to these questions should provide data points that can be investigated further to gain a stronger understanding of your company’s financial position.

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