It costs money to run a business. The purchases you make to stay up and running are typically referred to as business expenses, and they include the materials you use to produce the items you offer and the infrastructure necessary to manufacture and sell them. To calculate your business income, you subtract the sum of your business expenses from your gross receipts from sales of products or services.
Business Expenses Explained
The Internal Revenue Service defines a business expense as an ordinary and necessary expenditure for running your business. This IRS definition is important because it provides the basis for determining what you're allowed to deduct on your business tax return. Deductible business expenses offset your business revenue, or gross receipts, lowering the amount that serves as the basis for calculating taxable revenue. The less you spend on business expenses, the higher your profit. Although, as a business owner, you naturally want to earn as much as possible, high earnings increase the amount you owe in taxes. The more you can deduct as business expenses, the lower your tax bill.
Some Common Business Expenses
Business expenses are often divided into fixed and variable, although the distinction is far from clean. Fixed expenses include items whose cost doesn't change measurably relative to the amount of business you transact. Rent is a fixed expense, as are business licenses and membership fees. Utilities are usually considered fixed expenses as well, even though they increase somewhat along with your business volume. Variable expenses correlate more directly with overall sales and include costs such as materials and labor, which go directly into the finished products that you provide for your customers. Some large business expenses, such as major pieces of equipment, are classified as depreciable expenses. These are deducted from your gross revenue over time, using the assumption that their value to your business is spread out, even though you may have paid for them all at once.
Business Expenses as Percentages
One way to measure the health and efficiency of your business is to calculate the sum of a particular category of expense as a percentage of gross revenue and compare that percentage to the average for your industry. For example, in the restaurant industry labor costs can range from 25 to 40 percent depending on the type of food served. Food costs typically run about 33 percent but can vary widely based on the type of cuisine. In general, a food service business shouldn't spend more than 66 percent of its gross revenue on ingredients and labor combined. You may find it useful to compare expense percentages over different years to get a sense of whether your business model is financially sustainable and whether your variable costs are increasing or decreasing.