What are Expenses?
You may have heard an old adage that says that it takes money to make money and nowhere is that more true than in the world of business.
All you have to do is glance at the Income Statement to see just how much a business has to spend to generate Revenue.
The amount a company spends to generate income and to keep afloat is called Expenses.
Businesses have lots of expenses, but to understand the functioning of the company better and to make it easier to read the financial statements, the various types of businesses are categorized differently when being reported by accountants.
These categories can be seen in the Income Statement and are
1. Cost of Goods Sold
Cost of Goods Sold or COGS measures what a company must spend to create the good or service that has to be sold.
In a service business, the Cost of Goods Sold is often referred to as the Cost of Sales.
For many businesses, especially manufacturing ones, the COGS may be the single largest cost of doing business.
For instance, for a tire maker, the cost of goods may include the cost of raw material to make the tires and the cost of transport of the raw material to the manufacturing facility.
When cost of a raw Material goes up, the company COGS may increase thereby reducing company profits. If your an investor, watch out for commodity price fluctuations in the industries you have invested in since large fluctuations in commodity prices may make or break the fortunes of a company. You can always access commodity prices by checking them on Bloomberg by clicking here.
2. Operating Expenses
There are certain expenses incurred by businesses which do not go directly into making the product or providing a service.
Such expenses can be classified as Indirect Expenses.
These indirect expenses are also often referred to as overhead.
Operating Expenses are of many types and include
3. Non Operating Expenses
Not all expenses incurred by a business relate to the running of the company.
Some expenses result based on the type of financing the company management has taken to run the company such as interest on debt.
Too much debt can be really bad for the company and can really hurt company profitability. A good way to see if interest expenses are having a negative impact on the company is by analyzing a ratio called the Interest Coverage Ratio.
4. Capital Expenses
Businesses constantly need to upgrade to keep up with changing times and remain competitive. Capital Expenses are expenses that businesses make to upgrade the physical assets of the company such as buy new machinery, property, plant or equipment.
5. Extraordinary Expenses
Every once in a while, a company may incur an expense that is unusual in nature and may not be part of the core business that the company conducts. Expenses such a Legal Fees, damage due to natural disasters or write off of an intangible asset are non recurring and rare and are classified as Extraordinary expenses.