What is an Expense? Understanding the Basics

The idea of expenses being beneficial may seem odd at first, but expenses play an important role in accounting and taxation processes. 

Regardless of industry, every business will have income and expenses to report, and effective reporting can make all the difference when it comes to retaining profit.

But, what is an expense really? Working with expenses is a major part of business administration. You have an opportunity to write off certain tax-deductible expenses according to the IRS’s policy and documentation on the subject.

More important, however, is the chance to boost revenue by keeping expenses in check. Properly monitoring procurement promotes lower costs without compromising on sales figures. 

Let’s talk about how financial departments and accountants should approach the topic of expenses, the different types of expenses to be aware of, and different metrics and strategies you can use to drive the most value out of your expenses.

Understanding Expenses

It doesn’t take an expert to understand that you have to spend money to make money. Expenses are essentially any cost a business incurs in order to generate revenue. 

Modern companies have to work with dozens or even hundreds of expenses every financial period. Only a few examples might be:

• Employee wages
• Equipment repairs
• Utility bills
• Property rent or leasing
• Advertising services

While it may seem tempting to reduce all of these costs incurred, remember that cutting down spending too much can lead to reduced performance. For instance, not paying for training services for the marketing team might result in fewer sales, leading to a lower net income and a smaller chance for the team to generate revenues for that quarter.

Accountants record expenses through income statements. They might record them as soon as they are paid on a cash basis or might use the accrual method to record all of them together when the expenses are incurred. The accrual basis is more popular as it allows you to report on revenues and costs together at the end of an accounting period.

Types And Examples of Business Expense

It’s easy to conclude that companies work with a large variety of potential expenses, but we can still group them into a few main categories.

Purpose

These categories show us what the transactions are intended to “serve.” As most accountants are already well aware, expenses can come in two forms of procurement:

• Direct procurement: Purchases directly involved in the creation of a company’s products or services to be sold. Raw materials for the production line are common examples of direct costs.
• Indirect procurement: Any transactions made to support the internal operations of a company. Examples include travel expenses, professional services, and software licensing fees.

The exact proportions depend on the nature of the company. A manufacturing plant will naturally have more direct purchases, whereas a software service provider would probably spend nearly exclusively on indirect transactions.

There are other types of business expenses of course, including employee travel, food costs, reimbursement, etc.

Capital Expenses

The capital expenditure (CapEx) is essentially the maintenance cost for the equipment and property owned by the business. Whether you want to upgrade your own technology or provide maintenance for a company building, you are working with capital expense.

The IRS treats capital expenditures differently for tax purposes according to the Internal Revenue Code, so financial departments usually write them off slowly over time. The schedule for capitalizing on CapEx is different from that of other business expenses.

Prepaid Expenses

If you are expecting to incur expenses in the future and want to pay them now, you are paying prepaid expenses in advance. The purchase is considered an asset on the income statement until it’s paid off, when it becomes an expense.

There are far more categories too, but the takeaway here is that the high diversity of business expenses can make them difficult to manage without the right tools. We’ll talk more about expense management later, but we first must cover the concept of the Expense Ratio.

The Expense Ratio (ER)

Also known as the management expense ratio (MER), the Expense Ratio shows us what portion of a fund goes into administrative expenses. It’s calculated by dividing the fund’s operating expenses by the value of its assets.

As the operating expenses go up, the value of the assets go down. As a result, investors can use the ER to check on how much of a return they can expect from a fund.

The ER can come in several variations, such as the net expense ratio, the after reimbursement expense ratio, and others. Get in touch with your financial department if you want to know more about the ER.

The Importance of Expense Management and Reporting

We all keep track of our spending in our everyday lives, so it’s not difficult to imagine the same process on a larger scale for businesses and their accounting teams. Management and reporting are both essential steps in ensuring that spending stays in check and revenue remains high.

Expense Management

Accountants must review the expenses every financial period so that the company stays within budget and no excessive spending takes place. At the same time, they must make sure any spending cuts don’t result in unwanted reductions in operational efficiency or the quality of the products and services produced.

Expense management also extends into how money is handled day-to-day. Policies must be in place for employees to follow regarding the use of company funds. For instance, during business trips, staff members must know their allowances for food or lodging.

Finally, expense management is key to employee reimbursement for those transactions. Through efficient paperwork and data processing, financial teams are able to approve and issue payments back to employees promptly.

Expense Reporting

In reality, not all expenses are carefully considered by the accounting department and filed through formal paperwork. Sometimes, a business purchase must be made out “on the field,” such as when an employee on a business trip buys a meal between meetings.

It can be easy for these transactions to fall through the cracks in your expense reporting procedures. How can you make sure they’re all accounted for? An expense report is designed to itemize every purchase made on behalf of the company, whether we’re talking about office supplies or the aforementioned meal. Such a document may include:

• The employee making the purchase
• The date and amount of the transaction
• The type of expense
• The name of the vendor
• The exact business account from which to withdrawal the funds
• Any other additional descriptions

Naturally, expense reports are filed by employees so that they may be reimbursed for certain purchases later. The company must check whether all the items on the report are eligible for reimbursement before following through with the payment.

How Software Can Help with the Management and Reporting of Expenses

Despite the importance of expense management and reporting, surveys have indicated that few companies actually get these processes right. Nearly half of organizations don’t know how much it costs to process expense reports, for example.

So what’s the best approach to controlling business expenses? Automation has a strong potential to make an impact thanks to the data-heavy nature of management and reporting. The benefits that an expense management software solution might offer include:

• Faster processing: By cutting down on manual paperwork, you are making the entire process faster and more efficient while reducing the chance of human error muddling the results. It can take up to 20 minutes to process a single expense report, so it’s no wonder businesses are looking for better solutions.
• More convenience: One point of friction is forcing employees to record every transaction. Most software now comes with integrated mobile applications for quick receipt scanning out on the field.
• Data and analytics: These solutions can also generate insightful observations quickly from the spending data so that accountants can make adjustments to financial policy.
• Integrations: If you already use any other business tools like enterprise resource planners, there’s a solid chance it will integrate well with the expense management platform. Data can be transferred directly from one tool to the next for a seamless experience across the board.
• Policy enforcement: Software can also check for policy violations comprehensively. Every time a new transaction is recorded, it can notify upper management immediately.
• Auditing: Every step taken, from submitting a receipt to approving an invoice, contributes to a digital trail that makes financial auditing easier.

There’s no reason not to take advantage of these digital tools for your expense management and reporting needs. The falling cost of implementation thanks to SaaS platforms puts these benefits within reach of even small businesses, so be sure to make this type software solution your next major investment. Ready to explore expense automation for your own business needs? Learn more about how Tipalti Expenses can save you time, money, and hassle.