Keeping track of how the expenses incurred by a company evolve is a critical task that small business owners and financial managers should not underestimate when it comes to improving or maintaining a business’s profitability ratios over time. With the increased adoption of digital accounting solutions, this task has been facilitated. Still, it demands the constant supervision of someone who can quickly identify and correct an abnormal fluctuation in the company’s overhead.
Going from the interest expenditures associated with small business loans to payroll, keeping track of business expenses is part of a company’s day-to-day operations. The following post will discuss related considerations while recommending certain practices that can help entrepreneurs keep things in check.
What are business expenses?
The term “business expenses” typically refers to the indirect costs associated with running a company. This distinction is commonly made to exclude certain disbursements directly related to the production of goods – known as direct costs. These direct costs include the company’s raw materials and labor needed to render its services or manufacture its products.
In contrast, business expenses, also known as operating expenses, are those associated with the day-to-day back-end operations of the company. These expenses go toward marketing, sales, tech support, and others of the like. Depending on their nature, destination, and how they are treated from an accounting perspective, business expenses can be classified as follows:
By their relationship with production or sales volumes:
- Fixed or variable: a fixed expense remains unchanged regardless of how sales or production volumes behave, while variable expenses fluctuate alongside the company’s books.
By department or activity:
- Sales and marketing expenses.
- General expenses.
- Administrative expenses.
- Accounting expenses (depreciation, amortization, fair valuation assessments).
- Financial expenses (interests on small business loans and other similar disbursements).
- Other expenses.
By their periodicity:
- Recurring and non-recurring expenses.
By their impact on the company’s cash flows:
- Cash and non-cash expenses.
Regardless of how they are classified, business expenses are made daily and typically affect its operating profitability.
How can a business track its expenses?
Software companies have created applications that have facilitated the process of bookkeeping – especially for small businesses. These programs can easily integrate with the business’s bank account to download all the data from daily financial transactions. The owner or the person in charge of keeping track of the company’s finances can categorize each expenditure accordingly. This kind of program makes it possible to create reports and dashboards to track how expenses evolve periodically. Small business owners can use this information to assess if there has been a significant deviation that could affect the company’s cash position.
The importance of keeping updated financial records
For any business, not keeping updated financial records would mean that business owners will lack the information they need to make timely decisions about their finances.
Even though bookkeeping software has facilitated this task, there are cases in which small business owners fail to separate their personal finances from those of the business, which causes confusion and significantly distorts the company’s financial statements. To avoid this, companies must have a separate bank account and implement adequate internal controls to guarantee that all transactions will be recorded as they should in the accounting software.
Using a budget to keep track of how expenses behave over time
A budget is a financial tool that allows business owners to plan how the company’s income statement should look in the next quarter or year. For mid-sized businesses, budgets are typically drafted upon identifying the most critical cost centers.
Each cost center is an operational unit of the business that has its budgetary restrictions. When combined, all individual budgets should result in a company’s proforma income statement and sales projections. The most efficient way to track how business expenses evolve is to periodically analyze if there have been deviations between the budget and the actual results for each cost center.
Moreover, managers can align each department’s interests and goals with those of the company by developing incentives tied to their respective budgets. In practice, one way to do this is to offer compensation if their actual expenditures land below the budgeted amount.
Budgeting for a small business
Meanwhile, for smaller companies, a budget can be a well-drafted Pro-forma income statement. All relevant expenditures are broken down and forecasted based on previous trends. The easiest way to do this is to analyze how certain expenses have evolved in the past as a percentage of the company’s total sales. If the rate has been relatively similar in previous years, there should not be a reason to think that they will be too different in the future.
By doing this, small business owners can assess the impact that certain items such as interest expenditures on small business loans will have on the company’s bottom-line results. As a result, they can make adjustments accordingly to improve profitability down the line possibly.
Best practices to keep business expenses in check
Tip #1 – Automate and use technology
Automating many internal processes will save time and resources as fewer people will have to be hired to do the same number of activities, while the people that have already been hired will have more time on their hands to focus on the more strategic aspects of the business. In this regard, using technology can help small businesses save thousands of dollars a year in areas like accounting, payroll, IT, marketing, and sales through the use of software-as-a-service (SaaS) solutions and subscription-based applications.
Tip #2 – Fixed costs are better if the business is growing
A fixed cost is better than a variable one if the company is expected to see its sales or production volumes grow in the future. The reason for this is that the fixed nature of these expenditures will allow the business to keep more money out of every dollar it makes in sales, which means higher profitability ratios.
Tip #3 – Constantly research how to improve your practices for relevant activities
There is always a better way to do everything. Going from how the company manages its marketing campaigns to which lender it picks when seeking approval for small business loans. Researching what competitors are doing and learning the practices people follow in building their small companies can be a great way to identify new strategies to cut down business expenses.
Tip #4 – Pay off your most expensive debt
Not all business debt is created equal. In this regard, the specific terms of each credit card, small business loan, and line of credit should be assessed to identify and pay down as fast as possible the commitments that produce the highest annual financial expenditures for the firm. In this regard, it is essential to look beyond the interest rate alone. The annual percentage rate (APR), which adds the impact of commissions and fees to your borrowing cost, will typically be a better estimation when attempting to identify the most expensive debt.
Now that you know what business expenses are and how you can keep track of them, you can follow some of these recommendations to cut them down and ramp up your company’s profitability. Meanwhile, in case your business is looking for the best small business loans out there, Camino Financial is a California-based online lender that offers quick response times and a wide variety of loans for you to pick from. Find out more about them here.
- Business Expenses: A Guide to Managing Your Costs Appropriately - February 28, 2022