How to categorize expenses for a small business

Think of the business supplies you buy and the bills you pay. If you have employees, you have salaries to pay and employer tax deposits to make. Your expenses could be daily, weekly, monthly and even one-time only. Then there are quarterly bills like tax deposits and annual expenses like business insurance and bonding.

How do you decide to set up expense categories for a small business? Most of us know how to balance a checkbook, but fewer people know how to prepare a financial statement.

Deciding how to categorize expenses for small business operations will help you understand what you’ll owe in business taxes, help you manage your business and plan for the future.

Jump ahead to learn about:

• Why categorizing business expenses is beneficial for small businesses
• How to categorize expenses for small business
• How do small businesses organize expenses for taxes?

Why categorizing business expenses is beneficial for small businesses

Small business owners sometimes lack basic financial knowledge to make informed decisions. For instance, restaurant owners may need to learn how much it costs them to open their doors daily. Or a cosmetics manufacturer might need help understanding how much it costs to make and ship various products.

Categorizing business expenditures helps you identify the vital performance metrics for your business. Example financial performance metrics gained from categorizing expenses include:

• Cost of Goods Sold (COGS) or Cost of Service (COS). Measuring all costs related to making your product or delivering the service.
• Gross and net profit margins. These metrics help determine the profit made after expenses are paid and the remaining money after taxes.

By understanding these metrics, businesses can improve their financial performance.

How to categorize expenses for small business

There’s no single “right” way to categorize your list of business expenses. First, you should categorize types of expenses based on your most frequent purchases and costs. Common business expense categories include:

• Advertising and marketing: The cost of placing ads on social media or hosting your website.
• Business insurance: Costs for general liability insurance, workers’ compensation, property insurance and other insurance premiums.
• Business travel: Business-related travel expenses, including airfare, business meals and vehicle expenses.
• Dues and subscriptions: Subscription costs to industry publications or membership dues for professional organizations.
• Employee benefits: Expenses related to employee benefits including health insurance, retirement benefits or 401K match.
• Financial expenses. Business credit card fees and interest payments, business loans and bank fees.
• Mailing and shipping: The cost of shipping orders and mailing correspondence.
• Maintenance and repair costs: Routine maintenance like equipment servicing, or repairing a broken vacuum cleaner.
• Office expenses: This includes office supplies, internet, telephone lines, ink cartridges for a printer, computer or point-of-sale systems.
• Payroll: Employee salaries as well as any wages paid to contract employees.
• Professional services. Professional fees from receiving help from a certified professional accountant (CPA) or legal professional.
• Rent or mortgage: If you rent or own office space, retail space, warehousing or workspace.
• Training: Brush up on skills or get certifications for business purposes.
• Utilities: The cost of your gas, electricity and water.

Use accounting software to categorize expenses easily

Accounting software can help you track spending. Even if you have loose receipts, expense management software simplifies tracking business expenses and ensures financial data accuracy.

Compare different software online to find one that works for your business. Some platforms have features better suited for larger companies, while others are designed for small business owners. Try to select software that lets you compare expenses and categorize spending.

What are capital expenses?

Capital expenses, such as buying equipment or vehicles, are one-time or occasional expenses that depreciate over time or a one-time tax deduction. Consider categorizing these separately when accounting for your business expenses.

For example, if you buy a delivery van and include it under regular, ongoing “transportation expenses,” it could throw off your budgeting of monthly gasoline and vehicle insurance costs.

How do small businesses organize expenses for taxes?

The IRS publishes several documents explaining business expense categories and deductions.

• IRS Publication 535 explains the expense categories for incorporated businesses.
• IRS Publication 334 gives self-employed people instructions on which expenses they can deduct on Schedule C.

The two tax filing categories differ mainly in multi-year tax rules and accounting methods. Larger businesses use accrual accounting for over $5 million in annual revenue, while smaller businesses use cash accounting.

Accrual accounting categorizes expenses and accounts for future income, like unpaid invoices and multi-year leases. Cash accounting means you categorize your expenses and account for the money and inventory you have on a cash basis.

Business expenses and small business tax deductions

Regardless of your chosen accounting method, some expenses are always tax deductible. As a small business owner, you want to claim every tax deduction you can to reduce taxable income and optimize cash flow.

The majority of small business expenses are tax deductible. However, according to the IRS, a business expense must be “ordinary and necessary” to qualify as a deduction.

Ordinary and necessary expenses are considered commonplace in your industry and you need to pay for these expenses to run your business. If it falls outside the IRS’ guidelines, the expense is non-deductible.

When you organize and categorize your list of expenses, it’s easy to determine deductible business expenses. Even if you have a bookkeeper or tax preparer, categorizing expenses saves time and money on income tax preparation.

How NEXT helps small businesses thrive

Did you know that some insurance is tax deductible? While we can’t do your bookkeeping, we can help you with affordable, customized business insurance.

NEXT specializes in insuring small businesses. We simplify getting and managing business insurance so you can focus on growing your business.

You can get an instant quote, review options and purchase coverage fast. Get 24/7 access to your certificate of insurance (COI) as soon as you buy your insurance.

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