Although the terms cost and expense seem synonymous, be aware that they have important differences — especially when it comes to managing a company’s finances . After all, each of them represents different indicators.
For this reason, it is essential to understand what these concepts mean. Otherwise, if you confuse the expressions, you may have problems with the accounting and management of your business.
Want to find out the differences between cost and expense? Keep reading this post and find out more!
What are costs?
Costs are expenses incurred in order to produce goods or services. In this way, this outlay is directly related to production, and is considered according to the core activity. In other words, without these expenses, production would be compromised.
Thus, costs may include:
- acquisition of raw materials;
- hiring and paying operational staff;
- employee training;
- purchase of machinery and tools;
- facilities;
- between others.
For a better understanding, imagine a clothing factory. In this case, the company’s costs are:
- fabrics;
- wages of seamstresses and other production workers;
- threads, buttons and other supplies;
- sewing and fabric cutting machines;
- needles and scissors;
- fabric paints;
- labels etc.
How can costs be classified?
Now that you know what costs are, it’s time to understand the costs’ classifications. This assists you in keeping your accounts more organized. It helps monitor cash outflows and, hence, cash flow.
Look!
Direct cost
Direct costs are those related to the products or services offered by the company, such as raw materials and production labor. Therefore, they are included in the calculation to arrive at the price of the product.
Indirect cost
Indirect costs are not linked to production. Therefore, they cannot be directly related to the product or service. In this case, they may interfere with the core activity, but they are not directly related to it. Some examples are technical labor and occupational safety.
Fixed cost
Fixed cost check with expenses that continue to be the equal regardless of the company’s month-to-month manufacturing. These consist of employee salaries, device upkeep, and different working fees.
Variable cost
Finally, variable costs are those that are unpredictable. In other words, they can fluctuate depending on the use of resources, company performance, unforeseen events, etc. This classification includes expenses with raw materials and extra labor.
What are expenses?
Once you know what costs are, it’s time to find out what expenses are. They are also expenses, but they are related to the maintenance of the company, such as administration and sales optimization. In this way, expenses function as a means for the business to function.
In this sense, even if the indicator is not directly related to production like costs, it is essential for the company’s development and growth.
Among the most common expenses are:
- utility bills, such as water, electricity, telephone and internet;
- commission for sellers;
- office supplies;
- marketing;
- building rental;
- food for employees.
How can expenses be classified?
Just like costs, expenses also have classifications that help with the company’s financial management.
Next, understand how they can be separated!
Regular Expenses
Regular expenses are predictable expenses that occur frequently. This is the case for taxes , administrative salaries, rent and utility bills.
Extraordinary expenses
Extraordinary expenses are not predictable and happen arbitrarily. Examples of such include fines, costs associated with repairing and purchasing broken machinery, costs associated with court proceedings, among others.
Fixed expenses
Fixed expenses occur frequently and regardless of the company’s productivity. This group includes internet bills, rent, bank fees, among others.
Variable expenses
Variable expenses can fluctuate depending on the use or performance of the business. These include water and electricity bills, overtime pay, bonuses and commissions.
Expenses by sector
Expenses can also be classified by sector. In this case, they can be divided into:
- administrative expenses : salaries of administrative staff, rent, property tax and cleaning;
- commercial expenses : marketing and sales campaigns, advertising material and advertising team salaries;
- operating expenses : office supplies, employee meals and infrastructure;
- financial expenses : taxes, bank fees and card machine fees.
What is the difference between cost and expense?
Once you understand what costs and expenses are, it is then time to find out the difference between these two terms. As you have seen, costs are usually those related to direct expenses in the production or the core business of the company.
Conversely, expense costs are known as the incurred cost to be borne to ensure the business will not come to a standstill. Therefore, they are not needed to be spent on a product or performing the service, whereas expenses will contribute to the development of the company.
Why is it important to differentiate between cost and expense?
You already understand the difference between costs and expenses. But why is it important to make this distinction? In practice, understanding both concepts helps you to keep your cash flow control organized and plan more efficiently.
After all, the terms and their classifications identify where the company’s money is directed, allowing opportunities to reduce expenses to be found. In addition, differentiation helps to point out problems in a sector, product or service.
For instance, separating marketing costs from the cost of production allows for understanding whether money spent on advertisement returns or not.
In addition, knowing the costs and expenses allows for analysis of the contribution margin of the products. The contribution margin is the difference between all expenses subtracted from revenue and is considered to be the gross profit of the sale.
Knowing the difference between costs and expenses will help in appropriate pricing of the product or service. As a result, this will contribute to finding a satisfactory profit margin.
In this post, you have understood the difference between cost and expense and the importance of understanding both terms. Now, you can apply these concepts to your company’s day-to-day activities to ensure even more efficient financial management.