In plain English
Expenses are recorded in the period they are incurred. Owner draws and loan principal are not expenses.
Good categories make the profit and loss meaningful.
Why it matters
Expenses decide your profit, and profit drives decisions about pricing, hiring and taxes. If expenses are miscategorized, you might cut marketing that is working or miss that software subscriptions have crept up. Clear categories make the profit and loss useful rather than just a number.
Expense records also support your tax return. Each expense should have a receipt or bill and a clear business purpose. If something is ever questioned, organized records are much easier to defend than bank statements alone.
Worked example
Rent $2,000, software $350 and insurance $400 are three monthly expenses.
How to handle it
- Categorize each expense to the account that fits it, using the same account each time for similar costs.
- Attach a receipt or invoice to each transaction, especially larger ones.
- Note the business purpose for meals, travel and other items where the reason is not obvious.
- Separate personal charges paid with business funds and record them as owner draws.
- Compare monthly expense totals to the prior month and look into big changes.
Common mistakes
- Recording loan principal payments as an expense, which understates profit and leaves the loan balance too high.
- Expensing an equipment purchase that should be recorded as an asset, which can distort profit and affect taxes.
- Putting personal purchases in business expense accounts, which can lead to incorrect deductions.
- Using different accounts for the same cost from month to month, which makes trends impossible to read.
Not the same as: Asset
An expense is used up in the current period, like rent or utilities. An asset keeps value into future periods, like equipment or a prepaid annual policy. See Asset.
Go deeper
- Expense Categorization Rules of Thumb: Practical rules for categorizing business expenses consistently: how to choose categories, handle gray areas and keep tax time simple.
Related terms
- Fixed asset: A long-lived item the business uses, such as equipment, vehicles or buildings.
- Form 1099-NEC: An IRS information return reporting payments to non-employee contractors above a threshold.
- Equity: The owner's stake in the business: what is left after liabilities are subtracted from assets.
Common questions
What is an expense?
A cost of running the business, subtracted from revenue to find profit.
Can you give an example of expense?
Rent $2,000, software $350 and insurance $400 are three monthly expenses.
Is every business expense deductible?
Not always. Some costs are limited or not deductible at all, and rules change. Check with your accountant or the IRS for your situation.
How long should I keep expense receipts?
Keep them at least as long as your tax records might be reviewed, and longer for items like equipment. Ask your accountant for the period that applies to you.
General information, not tax, legal or accounting advice. Confirm rules with the IRS, the NJ Division of Taxation or a licensed professional.