Expenses are the costs your business incurs to operate - salaries, rent, supplies, utilities, equipment, travel, professional fees. They're deducted from revenue to calculate profit. Not all expenses are tax-deductible, and expense timing affects cash flow.
Your expenses determine whether your business is profitable. You can have strong revenue but poor profit if expenses are out of control. Understanding what you spend, where you spend it, and whether it's growing faster or slower than revenue is critical for any business owner or accountant.
For small business owners, expense tracking answers the question "Am I making money or just moving money around?" If revenue is growing but profit isn't, expenses are the culprit. Categorizing expenses also reveals spending patterns: are you overspending on marketing relative to sales? Is salary growing faster than revenue? These insights drive real business decisions.
For accountants, expense categorization directly affects tax liability and financial statement accuracy. Miscategorizing an expense (e.g., tagging personal meals as business meals, or tagging a capital purchase as an operating expense) triggers audit risk and misstates profit. Clean expense records also speed up year-end accounting and make quarterly reporting reliable.
Expenses flow through your P&L (income statement) and reduce your profit. Here's the mechanics.
The flow:
Real example:
A freelance graphic designer has:
P&L for March:
Categorization matters: if the designer mislabels the $1,500 subcontracting as "equipment" instead of "cost of sales," the P&L shows higher profit ($4,973) but the cost structure is hidden. Accountants reading the P&L won't see that 18.75% of revenue goes to subcontracting, which affects scalability and pricing decisions.
Common expense categories:
Common mistakes:
Best practices:
Aarvo captures expenses automatically via bank feeds and receipt scanning. When a transaction lands in your bank feed, Aarvo flags it. If it's a receipt (from email or your phone), Aarvo's OCR reads the amount and vendor automatically, then suggests a category. You review and approve in seconds, not minutes.
The dashboard shows your expense breakdown by category, plus trends: is marketing spend growing? Is salary as a % of revenue increasing? You see your top 10 expenses and can drill into any category. This visibility catches anomalies: if the $500/month software subscription jumped to $1,500 in January, you'll see it immediately and can investigate whether it's a mistake or a planned upgrade.
For accountants reviewing client books, Aarvo's expense reports show clean categorization, receipt attach, and flags for unusual items. Many bookkeepers use Aarvo to pre-populate their monthly review, cutting review time by 60% because the messy work is already done.
An expense is money your business spends. Rent, salaries, office supplies, software subscriptions, car fuel, professional services - all expenses. You deduct them from revenue to calculate profit. If you earned $100,000 and spent $60,000, your profit is $40,000. Every pound out is an expense that either reduces profit (if it's a normal operating cost) or reduces cash (if you haven't paid yet).
Most are, but not all. You can deduct ordinary operating expenses (salary, rent, supplies, professional fees, utilities) if they're necessary for the business. You cannot deduct personal expenses, meals over certain limits, entertainment without business purpose, or capital purchases (you depreciate those instead). Keep receipts and categorize carefully - HMRC audits expense claims and disallows personal or questionable items.
An expense is deducted from profit in the year you incur it. A capital purchase (equipment, vehicles, buildings) is an asset you depreciate over multiple years. Example: $500 office supplies are an expense (deduct in year 1). A $5,000 computer is capital (depreciate over 3-5 years). The distinction matters for profit reporting and cash flow planning.
Every expense should be tagged: salary, rent, utilities, supplies, professional fees, travel, marketing, etc. Correct categorization matters because your P&L (profit statement) breaks out expense categories, showing where money goes. Tax returns also separate expense types. Use accounting software with pre-built expense categories - most modern platforms (including Aarvo) prompt you to categorize as you log receipts. Sign up free at aarvo.com/signup and Aarvo's OCR receipt scanner captures expense details automatically, then categorizes them for you - no manual data entry required.
Under accrual accounting (which most businesses use), you record an expense when you incur it, not when you pay. If you get a $2,000 invoice on March 15 but don't pay until April 1, the expense is recorded in March profit. This matches revenue and expenses to the period they belong to, giving you accurate profit figures. Under cash accounting, you record the expense when you pay - simpler, but less accurate for matching.
Overhead is the cost of running the business that doesn't directly produce revenue: rent, insurance, utilities, admin salaries, accounting software. It's different from cost of goods sold (COGS), which is the direct cost of producing your product or service. Overhead is often called 'fixed costs' because it doesn't change with sales volume - your rent is the same whether you sell $10,000 or $100,000 of product this month.
The total income your business earns from selling products or services, before any costs are deducted. It's the top line of your income statement and the starting point for calculating profit.
Cash flow is the net amount of cash moving in and out of your business over a given period. Positive cash flow means more money is coming in than going out; negative cash flow means you're spending faster than you earn.
Burn rate is how much cash your business spends each month relative to how much it earns. You calculate it by subtracting your monthly revenue from your monthly expenses. It's the speed at which you're running out of cash.