Lesson #7 - The Fifth Element – EXPENSES

Definition:

EXPENSES (also known as Costs) are outflows of economic benefits or cash.

Imagine EXPENSES as your “river” or “stream” of cash flowing outwards, and ASSETS as your “lake” or “reservoir” of cash. The larger the cash outflows i.e. EXPENSES that occur, the smaller the corresponding ASSET that will be left as its value diminishes or disappears.

Rising costs seemed to have another effect on Mr Smith...

EXPENSES are measured over a period or duration of time (for example over a year, a quarter or a month) whereas ASSETS are measured at a certain date or point in time (yesterday, today or tomorrow).

Examples:

1. Cost of Goods Sold

If you are in the business of buying and selling goods at a profit, you need to firstly purchase the product from your supplier.

You usually pay for the product at a lower cost then the price you will sell it, right? So that you can make a profit, otherwise, you will make a loss!

You generate REVENUE the moment the product is sold (as you receive cash) but at the same time, you will incur an EXPENSE. The EXPENSE is the ‘original cost’ that you purchased that product for. That ‘original cost’ is called Cost of Goods Sold.

2. Staff wages and salaries
When you pay wages and salaries to your staff, employees or workers, there will be an outflow of cash, which is an EXPENSE.

3. Bills! Bills! Bills!
When you pay bills, there will be an outflow of cash, which is an EXPENSE.

There are tons of examples of bills, a few of which are listed below: -

• Utilities – Electricity, Water, Heating, Internet, Phones

• Administration expenses – Postage, Cleaning, Stationery

• Rental of office premises

4. Depreciation

A fixed asset that you purchase and use will over time, reduces in value. Why? This is because there will be ‘wear and tear’ on it. This reduction in the value of your fixed asset is called “Depreciation” and is an EXPENSE.

For example, if you purchase a car, and that car lasts you for
10 years, the value of the car will 'drop' by 1/10^th of its value
every year. That ‘drop’ in value is Depreciation. By the 5^th year, it would have halved its value and by the 10^th year, its value would be zero as it is fully depreciated.

Maybe I shouldn't have chosen red as my car colour?

The Nature of Expenses:

EXPENSES are DEBIT in nature.

When EXPENSES get BIGGER or INCREASE, they will head in a DEBIT direction, which is its nature. Conversely, when EXPENSES get SMALLER or DECREASE, they will head in a CREDIT direction.

In Conclusion:

As EXPENSES are outflows of economic benefits, and a lot of EXPENSES relate to Bills, let’s listen to a song called “Bills, Bills, Bills” by Destiny’s Child.

Enjoy!!!