As a finance executive, one of the first things I do when helping companies build sustainable growth businesses is to analyze their planning and reporting framework. I focus specifically on the categories under which business expenses are reported. In this post I will briefly explain what expense categories are and why they are so important.
What are expense categories?
Expense categories are basically roll-up groups of expenses that have similar nature and characteristics. They are often defined by management and can vary between industries. However, some generic categories can be used across different lines of business.
For example, expense categories applicable for production companies such as ‘Inventory’ will probably not be a good fit for software companies that sell services and licenses rather than physical goods. On the other hand, generic categories such as ‘Business Travel’ or ‘Marketing Spend’ will most likely be used by many companies regardless of their industry.
Why are expense categories important?
Get valuable business insights
As step one, to make a meaningful analysis, you need to know what are the key drivers of your business and tailor your expense category and planning and reporting framework around them.
In step two, you need to unify your expense categories in both your accounting software and your forecast and budgeting tools. You cannot measure and improve something if you are not tracking it correctly. And to track it correctly, you need to report actual spend and planned spend in a consistent manner. If you are not doing that, you most likely will not be comparing apples to apples. Or you will have to spend a lot of hours on crunching numbers and doing manual adjustments to get to that stage.
Benchmark against competitors and industry
Adopting already established expense categories for your industry can help you benchmark against competitors and industry averages. It can also help you analyse if you are over or under investing in some key areas and identify and prioritise your company’s performance gaps.
Make a good impression to investors
Investors love well-organized and well-run businesses. One of the key indicators for that is the quality of your data and how you plan, track, and adjust your forecasts. A good expense category framework can help a lot with those tasks and will certainly be noted by your investors.
The expense categories we use at Payhawk:
Cost of Sales
This category is used for all costs associated with servicing customers and provisioning the subscription that they pay for. ‘Infrastructure and hosting costs for customers’ or ‘Card issuing costs’ are just a few of the sub-categories in this group.
We track our marketing spend by online, offline, events, PR and outbound to get a full picture of our customer acquisition costs from the different channels.
Facility and Administrative
This category includes all expenses related to rent, utilities, shipping, office consumables and all other administrative types of expenses.
Here we track all software subscriptions and licenses by department and also all internal infrastructure and hosting costs.
Travel and Entertainment
The category is self-explanatory. We track separately travel expenses (daily allowance, accommodation, and transportation) and representative expenses.
Any third-party services such as legal, accounting, HR, translation, etc.
Bank fees, debit or credit card fees, merchant fees, insurance costs and other expenditures within the finance department control.
We try to avoid this category. It basically exists for all immaterial expenses that cannot be classified in any of the other categories.
The bottom line
Expense categories play a key role in setting the appropriate planning and reporting framework for your company. Investing time in examining your business needs and drivers and tailoring your reporting framework around them pays off from day one. This will help your finance team to report a more detailed picture of your company expense management. And will also empower management to better analyse past performance and plan for the future.