What is the difference between operating and non-operating expenses?

Non operating expenses

Not all of the costs a business incurs relate to running the business itself.

These expenses, such as staff and advertising, are known as operating expenses.

Businesses also have non-operating expenses and perhaps some non-operating revenue as well, such as the cost and possible income stemming from a lawsuit.

,When you prepare an income statement for a business, it is good accounting practice to distinguish between operating and non-operating expenses and list them separately.

,Operating expenses are all the costs you incur to bring a product or service to market.

Non-operating expenses are costs that are not related to normal business operations, such a relocation costs or paying off a loan.

,What are Operating Expenses?Operating expenses are the costs a business incurs as part of its regular business activities, not including the cost of goods sold.

Here are some examples:,Administrative expenses,Office supplies,Salaries for administrative personnel,Commissions, marketing and advertising,Rent and utilities.

,Costs of some specialized services, such as hiring consultants or accountants, are also considered operating expenses.

,What are Non-Operating Expenses?Some business expenditures are incurred for reasons that donu2019t involve normal business operations.

For instance, the costs of relocating your business falls outside core business operations and would be recorded as a non-operating expense.

Another example of a non-operating expense is interest on borrowed money.

,Non-operating expenses also include one-time or unusual costs.

The expenditure required for a business reorganization as the result of a bankruptcy, or to pay expenses due to a lawsuit, are common examples of non-operating expenses.

Charges for obsolescence of equipment or currency exchange are also non-operating expenses.

,Expenses are Reported on the Income StatementOperating and non-operating expenses are listed in different sections of a firmu2019s income statement.

At the top the income statement, the cost of goods sold is subtracted from revenues to find the gross profit.

Operating expenses are listed next and are subtracted fro the gross profit.

The amount remaining after all operating expenses are subtracted is called operating income.

Income statement examples with answers

When analyzing financials of companies, I always look at the cash flow statement first and spend the most time on that compared to the other statements.

,The Income Statement: Answers how are we doing as a business.

It starts with revenue minus expenses to get net income.

,The Balance Sheet: Is a financial snap shot at a point in time.

In other words, at a given date, what were the Assets, Liabilities and Owners Equity of the company.

,For the Cash Flow Statement: the amounts of cash and cash equivalents entering and leaving a company.

It answers the questions of how are operations running, where is the money coming from and how is it being spent.

,Ill give two examples that will help you understand why I prefer the cash flow statement to analyze companies: ,1.

There is freedom within the Income Statement and Balance Sheet to choose how you treat certain transactions.

This creates a situation where two otherwise similar companies have financial ratios that tell a different story.

For example, I can decide if Id like to capitalize (treat an expense an asset and depreciate it over time) an asset on the balance sheet or if Id like to expense it on the income statement.

If I expense it, my net income is lower and if you just compare income statements, I appear to be much less profitable.

,2.

Depreciation schedules are subjective as well.

You can choose a more conservative schedule which wil show more depreciation expense earlier on in the assets life or you can have a depreciation schedule thats the same expense each month.

The depreciation expense appears on your income statement each month as a subtraction from revenue.

Two companies that choose different schedules will have different income statements and balance sheets.

,On the cashflow statement, you see the actual cash that went in and went out of the business all in one place and the subjective decisions that each company can have do not matter.

Heres an example: When you are creating a cash flow statement using the indirect method (most popular and easiest to understand method), the first item at the top of the cash flow statement is called Net Income.

The next thing you to do that Net Income figure is, Add back non-cash transactions.

So look at the depreciation example we talked about above.

The depreciation is a non cash expense because you dont pay anyone a depreciation expense.

So no matter which depreciation schedule I choose, I have to add back my depreciation expense to Net Income.

If youre thinking, the depreciation expense that is the highest will add more money to net income than the other company, then youre correct.

The company though that has more depreciation expense though, started with a lower net income figure so each company appears to be even on the cash flow statement.

,For example in a sample cash flow statement it might look like this: , Company A Company BNet Income 200 100nDepreciation 50 150,Cash From Operations $250 $250,nIn conclusion, cash flow statements take the subjectivity out of the financial statements and give a more level playing field.