What is an expense? Definition, types and examples

Published Thursday 23 July 2026

Table of contents

• What is an expense?
• Types of business expenses
• How expenses are recorded
• Common examples of business expenses
• Expenses vs. costs vs. expenditures
• Tax deductions and IRS rules for business expenses
• How to track and manage business expenses
• Simplify your expense tracking with Xero
• FAQs on expense

Key takeaways

• An expense is a cost your business incurs during normal operations to generate revenue. Tracking expenses accurately is essential for calculating profit, filing taxes, and making informed financial decisions.
• Business expenses fall into several categories, including operating vs. non-operating, fixed vs. variable, and deductible vs. non-deductible. Understanding these distinctions helps you budget effectively and maximize tax savings.
• The IRS allows you to deduct expenses that are "ordinary and necessary" for your business. Common deductible expenses include rent, salaries, office supplies, and business travel.
• Using accounting software to categorize and track expenses in real time reduces manual errors, simplifies tax preparation, and gives you a clearer picture of your financial health.

What is an expense?

Understanding expenses is one of the first steps toward managing your business finances with confidence. Here's what the term means and why it matters for your bottom line.

An expense is a cost your business incurs during its regular operations to produce revenue. It's the money you spend on things like rent, wages, supplies, and marketing to keep your business running. Expenses reduce your net income, which directly affects your profitability and tax liability.

For example, if your business earns $100,000 in revenue and spends $70,000 on expenses during the same period, your net income is $30,000. That's the figure you'd use to assess profitability and calculate taxes owed.

Expenses are recorded on your income statement (also called a profit and loss statement) and are subtracted from revenue to determine your profit. Keeping accurate expense records helps you understand where your money goes, identify areas to cut costs, and stay compliant with tax regulations.

Types of business expenses

Not all expenses work the same way. Knowing how different types of expenses affect your finances helps you plan better, reduce waste, and take advantage of tax deductions.

Operating expenses vs. non-operating expenses

Operating expenses are the costs directly tied to running your day-to-day business. These include rent, utilities, payroll, marketing, and office supplies. Non-operating expenses sit outside your core business activities and include things like interest payments on loans, losses from selling assets, or lawsuit settlements.

In a survey of more than 1,000 business owners in the US and Canada, rent was the biggest operating expense for physical businesses, while over 1 in 4 online business owners reported marketing as their largest cost.

In the Federal Reserve's 2024 Small Business Credit Survey, 56% of firms cited paying operating expenses as a financial challenge.

The distinction matters for financial reporting. Operating expenses appear in the operating section of your income statement, while non-operating expenses are listed separately. This separation gives you a clearer view of how profitable your core business activities are, apart from one-off or peripheral costs.

Fixed expenses vs. variable expenses

Fixed and variable expenses behave differently as your sales volume changes. Understanding the difference helps you forecast cash flow and set pricing.

Fixed expenses stay the same each month regardless of how much you sell. Rent, insurance premiums, and salaried employee wages are common examples. You'll pay these amounts whether you have a busy month or a slow one.

Variable expenses rise and fall with your business activity. Raw materials, shipping costs, and sales commissions are typical variable expenses. When you sell more, these costs increase; when sales dip, they decrease.

Most businesses have a mix of both. Knowing your fixed costs helps you calculate your break-even point, while tracking variable costs lets you see how efficiently you're producing each unit of product or delivering each service.

Direct costs vs. indirect costs

Another way to categorize expenses is by how closely they connect to your products or services.

Direct costs can be traced to a specific product, project, or service. If you run a bakery, the flour, sugar, and butter for a particular cake order are direct costs. If you're a consultant, the hours you spend on a client project are a direct cost.

Indirect costs support your overall operations but can't be tied to a single product or service. Rent for your office, accounting software subscriptions, and general administrative salaries are indirect costs. These are sometimes called overhead expenses.

Tracking both types helps you price your products accurately. If you only account for direct costs, you might set prices too low to cover your overhead and turn a profit. For other hard-to-categorize costs, learn about miscellaneous expenses and how to handle them.

Deductible expenses vs. non-deductible expenses

Not every business expense can reduce your tax bill. The IRS draws a clear line between what you can and can't deduct.

Deductible expenses are costs the IRS considers "ordinary and necessary" for your type of business. These include rent, employee wages, business insurance, office supplies, and professional services like legal or accounting fees. You subtract these from your revenue when calculating taxable income.

Non-deductible expenses include fines and penalties, political contributions, and personal expenses. Some expenses are partially deductible; for example, business meals are typically only 50% deductible, and entertainment expenses are generally not deductible at all.

Keeping deductible and non-deductible expenses separate in your records makes tax preparation significantly easier and helps you avoid errors on your return.

Capital expenses vs. operating expenses

The timing of how you recognize a cost on your financial statements depends on whether it's a capital expense or an operating expense.

Capital expenses (often called CapEx) are large purchases that provide value over multiple years. Buying a delivery truck, purchasing commercial property, or investing in major equipment are all capital expenses. Rather than deducting the full cost in the year of purchase, you spread it out over the asset's useful life through depreciation.

Operating expenses (OpEx) are costs you incur and fully recognize within the current accounting period. Rent, utilities, and payroll are operating expenses you deduct entirely in the year you pay them.

This distinction affects both your tax strategy and your financial statements. Capital expenses appear on your balance sheet as assets, while operating expenses reduce your income directly on your income statement.

How expenses are recorded

The method you choose for recording expenses affects when costs appear on your financial statements and how your profit looks in any given period. There are 2 main approaches.

Cash basis accounting

Cash basis accounting is the simpler method. You record expenses when you actually pay them. If you receive an electricity bill in March but pay it in April, the expense shows up in April.

Many small businesses and sole proprietors start with cash basis accounting because it's straightforward and matches your bank balance. It's also acceptable for the IRS if your business has less than $31 million in average annual gross receipts.

The downside is that cash basis can give a misleading picture of profitability. A month where you pay several large bills might look unprofitable, even if the revenue those bills support hasn't been collected yet.

Accrual basis accounting

Accrual basis accounting records expenses when you incur them, regardless of when you pay. Using the same example, that electricity bill would appear as a March expense because that's when you used the electricity.

This method follows the matching principle: expenses are recorded in the same period as the revenue they help generate. It gives you a more accurate picture of profitability for each period, which is why the IRS requires it for larger businesses and why investors and lenders often prefer it.

For example, if you pay $12,000 upfront for a year of insurance in January, cash basis accounting shows the entire cost in January. Accrual accounting spreads $1,000 across each month, giving a more realistic view of your monthly expenses.

Common examples of business expenses

Seeing concrete examples helps you identify and categorize your own expenses. Here are some of the most common types, grouped by category.

Common operating expenses include:

• Rent or lease payments for office, retail, or warehouse space
• Utilities such as electricity, water, internet, and phone
• Employee wages, salaries, and benefits
• Marketing and advertising costs
• Office supplies and equipment
• Business insurance premiums
• Software subscriptions and technology costs

Cost of goods sold (COGS) typically covers:

• Raw materials used to create products
• Direct labor involved in production
• Shipping and freight costs for goods sold
• Packaging materials

Administrative and other expenses often include:

• Accounting and legal fees
• Bank fees and payment processing charges
• Business travel and transportation
• Depreciation of equipment and property
• Professional development and training

It's also worth knowing what doesn't count as an expense. Owner draws (money you take from the business as an owner), loan principal repayments, and the purchase price of assets you capitalize are not recorded as expenses on your income statement.

Expenses vs. costs vs. expenditures

These 3 terms are often used interchangeably in everyday conversation, but they mean different things in accounting. Understanding the distinctions helps you communicate clearly with your accountant and read your financial statements accurately.

A cost is the amount you pay to acquire something, whether it's a product, service, or asset. It's the broadest term and doesn't specify when or how you recognize the spending on your books.

An expenditure is the actual act of spending money or committing to a payment. When you write a check or authorize a purchase, that's an expenditure. It includes both items that become expenses and items that become assets.

An expense is the portion of a cost that's recognized on your income statement in a specific accounting period. It directly reduces your revenue for that period.

Here's a practical example. You buy a $24,000 piece of equipment (that's the cost and the expenditure). If it has a useful life of 4 years, you recognize $6,000 per year as a depreciation expense. The full $24,000 never appears as a single expense; instead, it's spread across multiple periods.

Tax deductions and IRS rules for business expenses

Tax deductions can significantly reduce what you owe each year, but the IRS has specific rules about what qualifies. Getting familiar with these rules helps you capture every legitimate deduction without risking an audit.

The ordinary and necessary standard

The IRS uses 2 criteria to determine if a business expense is deductible. According to IRS Publication 463, the expense must be "ordinary," meaning it's common and accepted in your industry. It must also be "necessary," meaning it's helpful and appropriate for your business. An expense doesn't have to be essential to qualify, just useful and relevant to your work.

Common deductible expenses

Many of the costs you pay to run your business are deductible. These include:

• Rent for business premises
• Employee wages and benefits
• Business insurance
• Office supplies and equipment
• Professional services (legal, accounting, consulting)
• Business travel, including flights, hotels, and car mileage
• Marketing and advertising

Partially deductible and non-deductible expenses

Some expenses come with limits or aren't deductible at all. Here's how they break down.

Partially deductible expenses include business meals (generally 50% deductible) and the business portion of a vehicle used for both personal and business purposes. To claim these, you'll need detailed records showing the business purpose.

Non-deductible expenses include fines and penalties from government agencies, political contributions, personal expenses, and entertainment costs. The IRS does not allow deductions for lobbying expenses, country club dues, or most gifts exceeding $25 per recipient.

Record-keeping requirements

The IRS expects you to keep records that support your deductions. Save receipts, invoices, bank statements, and mileage logs. For most business expenses, you should keep records for at least 3 years from the date you file your return.

Using accounting software to categorize expenses and store receipts digitally makes it easier to stay organized and produce documentation if the IRS requests it. Digital records are also more reliable than paper receipts, which can fade or get lost over time.

How to track and manage business expenses

Good expense tracking isn't just about staying organized. It helps you spot spending trends, prepare for tax season, and make smarter financial decisions throughout the year. A clear system also saves time when working with your accountant or applying for a business loan. If you're just getting started, the small business accounting guide covers the fundamentals.

Follow these steps to set up a reliable expense tracking system:

1. Separate your personal and business finances by opening a dedicated business bank account and credit card. This makes it easier to identify business expenses and simplifies bookkeeping.
2. Categorize your expenses consistently. Group them into categories such as rent, utilities, payroll, marketing, travel, and supplies. Use the same categories your accountant or tax preparer uses so your records align at tax time.
3. Record expenses as they happen. Waiting until the end of the month or quarter leads to missed expenses and errors. Capture receipts and log transactions daily or connect your bank to your accounting software for automatic imports.
4. Review your expenses monthly. Compare actual spending against your budget, look for unusual charges, and identify areas where you can cut costs. A monthly review also helps you catch duplicate payments or unauthorized transactions early.
5. Use accounting software to automate the process. Tools like Xero connect to your bank, categorize transactions, and generate spending reports automatically, saving you hours of manual data entry.

Simplify your expense tracking with Xero

Managing expenses doesn't have to be a time-consuming chore. With the right tools, you can spend less time on bookkeeping and more time running your business.

Xero's cloud accounting software connects directly to your bank, pulling in transactions automatically so you don't have to enter them by hand. You can categorize expenses, snap photos of receipts with the Xero mobile app, and generate real-time reports that show exactly where your money is going.

Whether you're tracking everyday operating costs or preparing for tax season, Xero gives you a clear, up-to-date view of your business finances in one place. Get one month free.

FAQs on expense

Here are some frequently asked questions about expense to help clarify common topics.

What counts as a business expense?

A business expense is any cost you incur as part of your regular business operations. This includes rent, utilities, wages, supplies, and travel costs that are directly related to running your business.

Is a salary considered an expense?

Yes, salaries and wages paid to employees are considered operating expenses. They're recorded on your income statement and are typically tax-deductible.

What is the difference between a cost and an expense?

A cost is the total amount you pay for something, while an expense is the portion of that cost recognized on your income statement in a specific period. For example, buying equipment is a cost, but the annual depreciation of that equipment is the expense.

Are capital expenses the same as operating expenses?

No. Capital expenses are large investments in assets that provide value over multiple years, such as property or equipment. Operating expenses are day-to-day costs like rent and utilities that you deduct fully in the period they occur.

What expenses can a small business deduct?

You can deduct expenses that the IRS considers "ordinary and necessary" for your business. Common deductible expenses include rent, wages, insurance, office supplies, and business travel. Some expenses, like meals, are only partially deductible.