Getting a handle on your expenses is crucial for understanding the health and runway of your business. Explore how to calculate, track, and manage them effectively.
Expenses are the costs a business incurs from its core operations, while revenue is the money it earns from selling products and services before paying expenses. Once you pay expenses, you get net income or profit, which equals the total revenues minus the total expenses from a given accounting period.
Additionally, you can calculate net income using its statement of owner's equity and use the result to calculate total expenses. This post looks at calculating, tracking, and managing your total expenses.
What are total expenses?
A company's total expenses refer to the sum of its costs spent toward running the business. For example, the expected costs of running a SaaS company include salaries, web hosting fees, software subscriptions, hardware repairs, transport, advertising fees, and equipment purchases.
If you think of total expenses as how much a company spends before its net income, you can use it as a metric to compare the spending habits over time
Total expenses for a given period refer to the sum of all the total gross cash expenditures plus any subsidiary pending, such as operating expenses, incentive fees, interest, and taxes.
A company may have considerable total revenues from its income statement. Then, as you go down the income statement, you start subtracting the following line items to get EBIT (earnings before interest and taxes):
- Cost of goods sold
- Research and development
- Selling and marketing costs
- General and administration
- Other expenses
Once you reach EBIT, you will subtract interest and taxes to achieve net income or "the bottom line."
How to calculate total expenses?
Before calculating total expenses, it is critical to know the difference between revenue and income. Revenue is the money earned after selling products or services before paying expenses. Income refers to total profits (net income) after subtracting expenses from revenue.
Below is a simple way of calculating total expenses from revenue, owner's equity, and income:
- Net income = End equity - Beginning equity (from the balance sheet)
- Total Expenses = Net Revenue - Net Income
If the result is positive, the revenue is more than expenses, making a profit. Conversely, if the number is negative, the company makes a loss because its expenses are more than total revenue.
Example 1: A company's equity grows from $200,000 to $800,000. Its total revenue recorded is $1,200,000. What are its total expenses?
- Net income = $800,000 - $200,000 = $600,000
- Total expenses = $1,000,000 - $ 600,000 = $400,000
The challenge comes in if other factors affect the owner's equity section. These include:
- A profit or loss
- Distribution to shareholders through cash dividends
- Raising new equity capital such as issuing shares or purchasing treasury stock
Example 2: A company had total revenues amounting to $800,000. It also had the following information in its equity section of the balance sheet: equity grew from $750,000 to $1.2 million, it paid $50,000 in cash dividends, and issued shares worth $150,000. Calculate its total expenses:
- Net income = [$1,200,000 (ending equity) + $50,000 (dividends paid)] - [$750,000 (beginning equity) + $150,000 (shares issued)] = $350,000
- Total expenses = $800,000 - $350,000 = $450,000
The formula above is helpful for reverse engineering a company's total expenses. However, a detailed breakdown of expenses throughout the accounting period is an invaluable management tool that can help track and cut costs, inform budget decisions, and support project growth.
How to track your total expenses
There are two primary methods of tracking company expenses. One is based on regularity or frequency, while the other is by type.
1. Tracking expenses based on the frequency
Accountants categorize expenses based on frequency or regularity because of their predictable nature. What better way of estimating future spending than using past spending?
- Fixed expenses refer to the standard charges that occur on a determined date and for a determined amount during the financial year. These include bills like internet or rent.
- Recurring expenses constitute fairly regular costs on your balance sheet even though they are not standard in value or time. These include office supplies, business lunches and dinners, and sundries.
- Non-recurring expenses are unpredictable. Still, they're inevitable expenses and include unscheduled system maintenance or surplus phone charges.
- Extraordinary expenses refer to disaster scenario costs, including flooding, uninsured lawsuits, and medical emergencies.
Tracking expenses based on frequency can help you flush out hidden costs such as a software subscription you forgot to cancel. It also allows you to keep separate expense accounts to assist in budgeting and creating better projections.
2. Tracking expenses by type
The second method of categorizing business expenses is by type:
- Sales and marketing (S&M)
- General and administration (G&A)
- Research and development (R&D)
The main reason for this categorization is to determine how a company spreads its spending and compare those ratios to competitors. For instance, a data management company might use this method to discover they spend twice as much on marketing than their competitors do and only half as much on R&D. Consequently, a newer and research-hungry competitor could overtake them soon.
How to manage your total expenses
It's easier to manage business costs when the business is in its infancy. However, managing total expenses gets more challenging as the business grows because it's harder to watch closely over every dollar spent.
The first step to managing your total expenses is tracking them using one of the two methods above—whichever suits your business. Once you accurately track your expenses, you can manage expenditure or consider using dedicated software. The former is time-intensive and prone to errors, while you can automate the latter, making it accurate and efficient.
1. Plan out your expenses
It's critical to plan and tightly manage all business expenditures and financial performance. Creating an efficient budgeting process is the best way to manage your operating costs and keep finances in check. It's easier to budget and expense for a small business, and budgeting will mainly entail controlling cash flows.
If you have enough accounting resources available, you could use the zero-based budgeting (ZBB) method to plan your expenses. Here, you allocate every dollar towards a business goal. It would help reassess these goals regularly to ensure each cost is necessary.
2. Improve how you track expenses
As the business grows, you start planning for new investment opportunities at the appropriate time. It isn't easy to have a hands-on approach with expense tracking and management at this stage. Hence, the need for accounting and expense management software.
Whatever expense tracking method you choose, an automated accounting solution can help you figure out where to allocate resources or cut costs. It gives an overview of your financial state and allows you to make informed decisions and develop smarter strategies.
3. Make people accountable for costs
Making people accountable for business costs eliminates unnecessary spending. For instance, you could print out your company's credit card statement monthly and identify each charge. You could then use different colors for different categories such as development, overhead, or marketing and tally the data in a spreadsheet to overview where your money is going.
Finally, ask the respective managers to account for the costs. The process could also help identify mistaken charges such as double deduction or double booking.
4. Track your expenses using phone applications
Dedicated phone applications for tracking costs and expenses are a great way to stay on top of your finances and track your total expenses. Find bookkeeping software that integrates directly with your phone apps to track and manage expenses when you are out and about.
5. Where possible, make your expenses as variable as possible
Variable expenses are flexible. You can dial them up and down when needed to suit your business needs and cash flow situation. For example:
- You could opt to use performance-based compensation as opposed to guaranteed payments
- You could rent and not purchase equipment
- You could lock in an option for future review instead of making it a contractual obligation
6. Review your vendors regularly
Review your key vendors annually or semi-annually. Remember to flag all automatically renewing contracts and subscriptions for review and rebidding where necessary.
Total expenses FAQs
What are the total expenses in the income statement?
These are a business's costs of generating revenue from its core activities. These include selling and marketing (S&M), cost of goods sold (COGS), general and administrative (G&A), research and development (R&D), and depreciation (amortization).
What are a company's total expenses?
These are the costs spent on running the business. For example, the expected costs of running a SaaS company include salaries, transport, software subscriptions, hardware repairs, web hosting fees, advertising fees, and equipment purchases.
How do you calculate total expenses?
Subtract your net income (or loss) from the total revenue. If the result is negative, treat it as a net loss.
Total Expenses = Net Revenue – Net Income
What are total expenses used for?
Expenses refer to money a business spends to ensure it can function and grow its core operations. Total expenses help calculate the net income (or loss) and evaluate business performance in financial accounting.
What are the different types of expenses?
The three primary types of business expenses are sales and marketing (S&M), general and administration (G&A), and research and development (R&D).