ARTICLE TABLE OF CONTENTS
Why Should I Categorize Business Expenses?
Dividing your small business expenses into categories offers several notable benefits. Having categorized expenses keeps things much more organized, which makes the task of managing your company’s finances feel less overwhelming. Likewise, when you have your business expenses properly categorized, you can construct future budgets much more easily. You can also identify areas where you may be spending too little or too much, which can help you optimize your company’s operations to boost profits.
Finally, having your small business expenses categorized is essential when it is time to prepare your annual tax return. While some of these expenses are deductible, others may not be. In addition, different types of expenses may need to be included on your tax return differently. Carefully organized expenses will allow you to complete your tax return accurately without as much stress and confusion.
What Categories Should I Use?
The goal of categorizing your expenses is to group like costs together. However, it is important to optimize the number of categories you choose. Listing too many categories can be confusing and make it impossible for you to see trends. Likewise, failing to list enough categories defeats the purpose of categorizing your expenses in the first place.
Every business is unique, so you may not have the exact same list of expense categories as another company. However, in general, most businesses will be able to categorize their expenses under the following headings:
If you have employees, payroll is a category you will definitely want to include when you organize your expenses. In fact, for most companies, payroll is the largest expense on the list. Seeing this expense listed separately will make it easier for you to deduct from your taxable income, as well as to see how it is impacting your company’s profits. This expense categories can include hourly wages you pay to employees, as well as salaries, bonuses, commissions and other forms of monetary compensation.
2. Employee Benefits
Just like payroll, employee benefits are another large expense for most small businesses. Employee benefits include costs like employer-sponsored health insurance, life insurance, retirement contributions, conferences, paid vacation, and any other expense you incur when providing extra compensation to your employees. List these expenses separately so you can see how they are impacting your bottom line. Many of these expenses will also be tax-deductible, allowing you to reduce what you owe to the IRS.
3. Rent and Utilities
If you are renting the space where your small business operates, you are likely making a monthly rent payment. Whether or not you are renting the space, you probably have utility expenses as well. These expenses include the cost of water, electricity, gas services and trash pickup. Some businesses may also include the cost of phone and internet in this category, while others may create a separate category to account for these communication expenses. Include all of these costs in the “rent and utilities” category.
If you work out of your home, keep in mind that you won’t be able to deduct the full cost of your utilities and communication expenses on your taxes. You will be able to deduct only the portion of those expenses that apply specifically to your business operations and space. For this reason, it is important to keep careful records of these expenses so you can allocate the correct portion of each expense to business activities.
4. Marketing Expenses
Marketing or advertising expenses is another common category shared by the majority of small businesses. This category encompasses the cost of any activity or service designed to promote your business. Common examples of marketing expenses include:
- Ads in printed or digital magazines and newspapers
- Mailed advertisements
- TV or radio advertisements
- Email marketing
- Search engine marketing
- Social media marketing
Expenses should be categorized under this heading if they are related to the production or publication of marketing materials. For example, if you produce a video to post on the internet for advertising purposes, you can include both the cost of making the video and the cost of distributing it in this category.
5. Office Expenses and Supplies
Your office expenses category should include all of the expenses you incur while operating your office. For example, this category may include the cost of computer or phone equipment and software. This category of expenses should also include costs related to the supplies you purchase for your office, such as pen and paper, printer ink, postage stamps, staplers and other office items. Office furniture may be included in this category as well.
6. Travel Expenses
Travel expenses are those expenses you incur when you travel for the benefit of your business. Examples include traveling for a business meeting, sales event or industry-related conference. Some of the expenses you should list in this category are the cost of airfare, food purchased while traveling, lodging expenses, and other transportation, such as rental cars or train tickets. Keep in mind that these expenses are often a source of stress at tax time, so keep careful records and retain your receipts for future reference.
7. Meals and Entertainment Expenses
Meals and entertainment expenses that are directly related to your business and its operations should be listed in this category. These expenses may include taking a client to dinner, paying for a catered lunch for your staff or even treating your staff to a concert or sporting event as a reward for their hard labor. Holiday parties may be included in this category as well.
Keep in mind that the tax laws regarding these types of expenses are complicated and subject to change. While some meals and entertainment expenses are still deductible, others are no longer tax deductible for business owners. This category can be useful for budgeting and business analysis, but you may need to break it into smaller categories when it is time to prepare your tax return.
8. Business Vehicles
If your small business owns or leases vehicles for business purposes, it is important to have a separate expense category for these costs as well. Some of the expenses you may include in this category are:
- Oil changes
- Tire replacement
- Registration fees
- Lease payments
- Vehicle loan interest
When keeping track of expenses for business vehicles, be sure to keep careful records of any costs that were related to personal use of each vehicle. It is also important to keep track of the mileage driven for different purposes during the year, as this information will be essential when you file taxes.
9. Professional Services
If you pay for professional services, you will need a separate category to keep track of the related expenses. Examples of professional services include outsourced payroll, legal consultation, tax preparation and marketing consultants. You may also include the costs of fees paid to tradesmen hired to make repairs or perform maintenance for your business and its buildings.
Nearly every business will need to purchase various types of insurance to protect themselves from liability and loss. In this category of expenses, include the premiums you pay for general liability insurance, professional liability insurance, product liability insurance, disability insurance and worker’s compensation insurance. Keep in mind that health insurance is usually included under employee benefit programs, so be careful not to list it twice.
11. Dues, Subscriptions and Licensure Fees
Depending on the nature of your business, you may need to create another category to cover certain professional expenses. These expenses may include membership dues for professional organizations, subscriptions to publications, licensure fees and expenses related to permits.
12. Business Interest
If you are paying interest on loans that are not included in other categories, you may need to create a separate category for miscellaneous business interest. For example, if you took out a loan to buy inventory or you use business credit cards, this category would contain the related interest you pay.
This list of categories may not include every possible expense your business incurs. If you have expenses that don’t fall into any of the categories listed above, you may need to add additional options to the list.
How to Keep Track of Categorized Expenses
Keeping track of your small business’ categorized expenses is easier than it may seem. Once you have determined which categories you will use, you simply need to develop a system that allows you to record old and new expenses in each of these categories. Most business owners find that this process is easier when they use accounting software to track the expenses they incur. You can also make categorization easier by adding codes to vendor invoices that indicate the category of the associated expenses.
For the best results, follow these tips:
1. Choose the right software.
A wide variety of options are available when it comes to accounting software. Do research to find the program that will most effectively meet your business’ needs. Keep in mind that the expense of purchasing or leasing this software is tax-deductible.
2. Stay ahead of the game.
When you are incurring expenses all the time, it can be tempting to let them pile up. Input your expenses into the software as they are incurred to avoid getting overwhelmed and/or letting some expenses fall through the cracks.
3. Keep your receipts.
Keeping records of each expense is essential not only for accuracy, but also to support your business in the event of a tax audit. Make sure you are keeping your receipts even after you have entered expenses into your accounting software.
4. Outsource accounting if needed.
If your business does not have the resources to handle categorizing expenses and other accounting tasks in-house, consider outsourcing your accounting needs to a third party who can handle these tasks for you. Although this may cost a little extra money, you may find that your accounting is more accurate in the long-run, and that you experience less stress as a business owner.
A Note About Tax Deductions
Disclaimer: Please keep in mind that the content of this post is not intended as tax, accounting or legal advice. The information presented here is for informational and educational purposes only. Before engaging in any transaction, be sure to discuss these matters with a trained, licensed professional.