What are expenses and what are the different types?

By Indeed Editorial Team

Published 26 September 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Whether you're operating as a sole trader and running your own business or working as an employee in a payroll or HR department, it's essential to understand what expenses are and how they work. Expenses are costs to a business on which they don't capitalise. Tracking and reporting your expenses can save you or your own business money when filing your taxes. In this article, we answer 'What are expenses?', explain what the different types are and outline how to claim them.

What are expenses?

Expenses are business costs on which the business doesn't capitalise. Businesses incur costs to generate revenue and these costs may include anything from staff salaries to tax expenses, insurance, rent and utilities, fuel, stationery and advertising costs. All costs that a business incurs during a specific accounting period count as expenses and accountants record them in the business's profit and loss (P&L) or income statement. The P&L statement provides a brief overview of a company's finances and is useful in determining the organisation's financial health.

Expenses may differ depending on whether you're working for a limited company or operating as a sole trader. Provided the expenses you incur meet HMRC guidelines, it's possible to write them off, which means a business doesn't pay any tax on the costs incurred while running the business. It's also possible to incur expenses even if the business isn't generating a profit. Additionally, claiming back the tax paid on expenses can have a significant impact on the business's profits and overall success.

Related: How to reduce costs (plus common mistakes to avoid)

Expense types

There are many different types of expenses that companies incur, but it's possible to divide them broadly into three main types, which include:

Related: Depreciation vs amortisation (definitions and examples)

Operating expenses

Operating expenses are the costs a business incurs due to its daily operations. They're usually short-term costs businesses incur during a particular accounting period, and almost all businesses incur at least some operating costs. There are two distinct types of operating costs, which are selling, general and administrative expenses (SGAs) and cost of goods sold (COGs). SGAs include all the costs that don't directly relate to the production of goods or services for an organisation, such as rent and utility bills, insurance, legal costs and travelling expenses.

In contrast, COGs are expenses that relate directly to the cost of producing goods or services. These might include the materials that businesses purchase to produce goods, alongside shipping and delivery costs and perhaps depreciation expenses. Depreciation expenses refer to the reduction in the value of an organisation's assets due to wear and tear. Usually, these apply to businesses with high-value assets, such as heavy machinery and specialist tools. Accountants record both SGAs and COGs under the operating expenses section on a P&L statement but display them as separate items.

Related: What are SGAs in accounting and how to calculate them?

Non-operating expenses

Non-operating expenses are expenses that an organisation incurs that don't relate to the organisation's core operations. Most accountants display non-operating expenses on the P&L statement after operating expenses and deduct these expenses from the organisation's operating profit. There are various types of non-operating expenses, including:

  • Interest expenses: This is the cost of borrowing money, such as the interest you pay when taking out a bank loan.

  • Loss on disposal of assets: This is a cost that a business incurs when eliminating an asset from the accounts.

  • Obsolete inventory changes: This is the cost of obsolete inventory or inventory that's at the end of its product life cycle. These expenses include older inventory an organisation hasn't sold and doesn't expect to sell shortly.

  • Lawsuit settlement expenses: This includes the costs involved in settling lawsuits.

  • Restructuring expenses: This includes the costs that a business might incur when restructuring to improve efficiency and performance.

It's common to record both operating and non-operating expenses on an accrual basis. This type of accounting method involves recording transactions and matching the incurred expenses within a particular accounting period with the revenues for the same period, rather than with the period in which the organisation pays for the expenses.

Related: How to track business expenses efficiently: useful tips

Capital expenses

Capital expenses include all the costs an organisation incurs when spending money to improve or maintain its fixed assets. Businesses with many fixed assets are more likely to incur capital expenses. Fixed assets may include buildings, computers, furniture, machinery, land, vehicles and software. In addition to maintaining fixed assets, capital expenses include the costs that a business incurs when purchasing new assets in these categories. For example, if a business spends money repairing the office building's roof or buying new computers for the office, these are capital expenses.

It's possible to divide capital expenses into two further categories, which are variable and fixed expenses. Fixed expenses are the costs a business usually pays first, such as rent, which the business may struggle to reduce or remove. Variable expenses are costs businesses have more control over, such as purchasing new equipment or paying a provider for a non-essential service. For these expenses, businesses may choose to reduce or remove these costs by foregoing the purchase or shopping around.

Related: What is CAPEX vs OPEX? Differences, uses and importance

How to claim expenses

Find out how to claim expenses by following these steps:

Related : EBITDA importance: how to calculate it (with example)

1. Claiming if you're self-employed

As of September 2022, self-employed individuals may claim for expenses when they file an annual self-assessment tax return with HMRC. These individuals, including freelancers and sole traders, may claim expenses for their business's running costs when filing their tax returns. For these people, it's possible to deduct the costs of certain expenses from the taxable profit they make each year. These expenses include money that they spend from either their personal or business bank account to pay for work-related costs. Some examples of these expenses include:

  • office costs, including rent and phone bills

  • clothing costs, but only if the business's function requires the owner and their staff to wear a uniform

  • travel costs, such as fuel and parking

  • raw materials and inventory costs

  • staff wages and the cost of hiring consultants

  • financial costs, including insurance

  • professional training course fees

  • advertising and marketing costs

Self-employed individuals may also claim capital allowances when they buy equipment or machinery that's solely for business use. If you use something for both business and personal use, you may claim this as an expense but only the proportion that's for business use. For example, if you want to claim money for your phone bill on expenses and you use your £200 monthly phone bill for 50% business and 50% personal calls, you may claim £100 of your phone bill as a business expense. You can check exactly what you can claim as an expense online.

Related: How to calculate tax-deductible expenses (examples and FAQs)

2. Claiming for a limited company

The rules for limited companies are different to those for self-employed individuals. The director of a limited company is responsible for keeping accurate company accounting records, filing a company tax return and paying corporation tax. When filing a company tax return, it's possible to claim for allowable expenses just as a self-employed person might. The key difference here, though, is that a limited company can only claim for expenses incurred when running the business. This means that operational and capital expenses that a business incurs for both business and personal use aren't permissible.

When you work for a limited company, you may incur allowable expenses through your personal account and claim them back later. Alternatively, you may use a business account to pay for all the business costs. It's essential to keep copies of all the relevant receipts for the expenses you want to claim because HMRC may ask to see them. Some examples of extra expenses that limited companies can potentially claim include:

  • cost of throwing a staff party or event

  • buying small gifts for employees

  • cost of eye tests and health checks for employees

Please note that none of the companies, institutions or organisations mentioned in this article are affiliated with Indeed.

Explore more articles