The Only 2 Types of Expenses Your Business Needs to Know About
Author: Russell SmithMarch 1, 2018
Looking to find out a little more about how business expenses work? Our accountants for small businesses talk through everything you should know.
Small business expenses are fundamental to any enterprise, no matter what size.
You cannot hope to start or run a business without spending money on it and, when any sort of payment occurs for the sake of business operation, it is categorised as a business expense. Business expenses are actually more straightforward than you might think.
There are only really two types of expenses that will be regularly coming out of your company. Knowing what they are and how they impact your financial health can help support strong economic growth.
Before we get into that nitty-gritty financial talk, our small business accountants are going to establish exactly what these two types of small business expenses are.
Looking to find out about tax-deductible business expenses, rather than the ins and outs of expense management? Take a look out some of our other blog posts:
Type of Expense 1: Overhead Business Expenses
Overhead business expenses refer to costs that occur passively, no matter what business activities are being undertaken. Common overhead expenses include:
- Gas and electricity supply
- WiFi and landline
- Accounting and bookkeeping services
- Loan repayments and interest
This list will vary depending on the type of business you operate, but the general idea is that overhead expenses are the foundational costs on which your business rests.
Type of Expense 2: Cost of Sales Business Expenses
Cost of sales business expenses are, by contrast, the complete opposite of an overhead expense. Otherwise known as “direct cost” expenses — I know, sorry for all the jargon — these types of outgoings follow the mantra of ‘you’ve got to spend money to make money’.
An example of a cost of sales expense would be when a restaurant orders ingredients for its meals. This is an unavoidable expenditure, as you cannot make a sale without the initial fiscal stimulus of those expenses.
There are plenty of other examples of this across all types of industries, from construction companies buying machinery to freelance journalists picking up a new laptop. If the expense results in your ability to sell, then it is a cost of sale business expense.
Small Business Accountants Talk Why It is Important to Know the Difference
Separation of these types of expenses helps promote financial control and stability.
These two different types of expenses need to be managed and recorded very differently. If you treat all expenses as equal, lumping them together in the same accounting sheets and giving them similar budgetary constrictions, you are setting yourself up for problems.
When it comes to cost of sales expenses, the simple matter is: the more sales you make, the more your cost of sales will need to increase to meet demand. If sales decrease, this expense will go down. Opposite to that, we have overheads. These expenses will not change unless new overheads are added, or if you find a way of reducing them/your supplier’s raise prices.
Because of the traits of these two types of expenses, our accountants for small businesses would recommend this management methodology:
- Separate your expenses into two monitoring platforms
- Allow for adaptive responses to cost of sales expenses, while trying to rein in overheads as much as possible
- Create individual accounts for records
- Align each type of expense with an individual budget
Never let the two become a combined element of your business. By keeping things separate, you ensure better financial health through practice and control.
Types of Expenses That Confuse Business Owners
As there are to every rule, there are exceptions to the two-type expenses principle. Specifically, we are talking about employee salaries.
Now, you might think that you would consider these overheads because they do not change regardless of sales. Except, in some circumstances, they do. In the service industry, where your staff are the cogs that turn the wheels of your business, essentially making them the ‘product’ you offer, they are directly responsible for income and, therefore, are a cost of sales expense.
The same, however, cannot be said for product sales businesses, where your staff are not the product and therefore only those who are in sales directly affect the outcome of the business’ financial success.
Then you’ve got to take into account administrative staff, which are overheads regardless of whether you work in services or product sales.
It is confusing, we know.
To record every staff member individually would be an incredibly complex process, so our accountants for small businesses recommend a simplified method:
If you are a service industry, record your salary expenses as a cost of sale, with the exception of administrative staff, who are always overheads. If you are a retailer, record all salaries as overheads.
Need help sorting out your business expenses? Our chartered accountants for small businesses are exactly what you need. From deciding how to record expenses, to organising your expense accounts, we can support every aspect of this delicate financial management process.
Russell Smith is an award-winning accountant and founder of RS Accountancy. With over a decade of experience running his company, he has worked with countless small businesses just like yours, helping them grow profits and manage their finances. Russell is also a prolific financial writer, having contributed to such publications as The Guardian, The Telegraph and The Daily Mail.