Introducing: Expense

May 25, 2009, 8:51 am

Small Business Finance & Profitability

By William Stong

The outgoing part of the Profitability equation.

Generically, “expense” may be defined as anything of value given up in order to obtain resources, services or labor. Almost always, expense precedes revenue.

In the simplest terms, expense is cash given in payment for materials or services. There is a continuum of paying for expenses, ranging from “Cash-Near Cash through to Barter of Products or Services.”

How one pays for an expense shouldn’t be an issue. Whatever you receive in return for the payment is an expense to your business, whether you pay cash, use a credit card, exchange an asset or provide a service as payment.

Accounting for expenses, and when to book them, is relatively straightforward although some knowledge of basic accounting principles is helpful. If an expense is not paid in cash, then it is important to track when whatever was given (e.g., an I.O.U.) converts to cash (usually the “Near Cash” items, not the bartered products and services).

Expense, by itself, is merely a quantity: it only shows how much was paid. It is silent as to the effectiveness of the expense: it doesn’t tell you whether you are going to make money. Neither does it tell you whether you under- or over-paid. Qualitatively, expense is neither positive nor negative until the effectiveness of the expenditure is measured.

No profit can be made without some level of spending.

Companies spend their money differently–or at least report it differently (I assume Ford spends on R&D).

	HP	Pfizer	Ford	Kroger
Cost of Sales	83%	21%	79%	80%
R&D	3%	20%	0%	0%
GS&A	12%	38%	13%	18%
All Other	2%	21%	7%	3%

Expenses by Type; as % of Total Expenses Source: Company websites; Annual Rpts ($bn)

Expense is the Organization’s Ante

Resources of some sort must be expended before there is any chance of receiving revenue. Even a beggar spends before receiving any handouts. He (or she) spends time, effort and, maybe, money to get to the spot where donations will most likely be received.

Businesses spend time developing ideas, writing business plans, completing proofs-of-concept and prototypes long before revenue is a glimmer on the horizon. These are necessary activities.

Expenses, therefore, are an organization’s ante to get into the game. The bet is that the spending is astute enough to generate a market and customers for its products and services. Without the ante, there is no opportunity to win the pot. A key concept for businesses to master is “Time-to-Revenue.”