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Business owners are constantly thinking about company finances.
How do I maximize my company’s profit margin? Should I spend more on advertising or research? Is my business growth sustainable long term?
The answers to all three questions can be found between the lines of your expenses. This article will cover what expenses you should track, and how you can calculate and manage them over time.
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What are Total Expenses?
A company’s total expenses is the sum of all costs spent towards running that business.
Salaries, web hosting fees, transportation, software subscriptions, equipment purchases, hardware repairs, advertising fees etc are just some of the types of costs that compose a SaaS company’s expenses.
Total Expenses are also one of the key metrics for growth analytics.
Help: How do I calculate my total expenses?
Haven’t been keeping track? Not to worry.
Here is a simple way to calculate your total expenses from income, revenue and equity.
Net Income = End Equity – Beginning Equity
Total Expenses = Net Revenue – Net Income
For example, a company’s equity grows from $100,000 to $1,000,000. The Net Income is therefore $900,000. Its recorded Total Revenue is $1,500,000. The Total Expenses must have amounted to $600,000.
While this is a useful formula to reverse engineer your total expenses, keeping a detailed breakdown of expenses as you go is an invaluable management tool for your business that can help cut costs, project growth, and inform budget decisions.
Tracking Total Expenses
A small web development company grows their revenue from $4000 MRR (monthly recurring revenue) to $7000. From revenue alone, the company appears to have nearly doubled its profit.
However, expanding the customer base has generated increased advertising, research and hardware costs. This raises the total monthly expenses from $3000 to $6000. The company’s net income has therefore remained the same at a monthly $1000.
In addition, their Cost Revenue ratio has actually worsened from 75% to 85%, rendering the company less attractive to business partners and investors.
Based on this information, the founder might choose to scale back and focus on their initial niche customer base, rather than continue to spend extra money and effort only to make the same net income.
Secondly, some expenses are fully or partially tax deductible. With accurate tracking, a business is able to profit from tax deductions and benefits, and potentially even move to a lower tax bracket entirely.
There are two major methods of tracking expenses. The first is based on regularity, and separates into fixed, recurring, non-recurring and extraordinary. The second categorises expenses by type.
Fixed, Recurring, Non-Recurring and Extraordinary Expenses – What Are They?
Fixed expenses are the standard charges that occur, as a rule, monthly on a determined date for a determined amount, such as the internet bill or rent.
Recurring expenses are not standard in time and value, but still constitute fairly regular costs appearing on your balance sheet. Office supplies, business lunches and sundries are examples of recurring expenses.
Non-recurring expenses are unpredictable, yet often inevitable expenses, such as unscheduled system maintenance and surplus phone charges.
Extraordinary expenses are the disaster scenario costs that hit out of the blue. Flooding, medical emergencies or uninsured law suits are examples of this.
So why categorise expenses based on regularity? Well, regular also means predictable. There is no better way to estimate future spending than basing it on past spending.
Separating expenses by regularity makes it easier to project your business’s costs in the short, medium and long term.
This method can also help flush out hidden costs like the software subscription trial you forgot to cancel.
Finally, based on this model you might decide to keep separate expense accounts, notably an emergency fund for extraordinary expenses. Not only does this help in budgeting, but also creates better projections.
A software engineer running their own One Person Company has a critical hardware failure. A last-minute replacement plus labour and emergency data recovery costs them $12000.
This lowers their annual profit by 10% compared to last year, and a projection of the company’s future success would take into account this negative growth.
As this cost is exceptional, however, it should not be taken into account for future projections. Keeping a separate expenses account ensures a more accurate cost model can be made.
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Sales & Marketing, General & Admin, and Research & Development
Another method of categorising expenses is by type: Sales & Marketing (S&M), General & Admin (G&A), and Research & Development (R&D). A key reason for separating expenses by type is to determine the spread of a company’s spending, and compare those ratios to competitors.
By using this method, a data management company might discover they are spending a percentage twice as much on marketing as their competitors, but only half on R&D. This may leave them open to being overtaken by a newer but more research hungry competitor in the near future.
An expense list itemised by amount and category also underpins a company’s ability to effectively allocate budgets to its different departments in the future.
Quickbooks Online is a great tool for tracking expenses using this method. We even made an easy-to-follow guide!
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Total Expenses Ratio
A Total Expense Ratio (TER) compares a company’s costs to its equity, expressed as a percentage, based on the following formula:
TER = Total Costs / Total Assets
The lower the percentage, the lower the proportional cost is to run that business.
This ratio isn’t just static – it also allows a company to track their performance over time.
A large project management company expands its client base. After one year, this results in a significant increase in both the business’ equity, and its costs. Tracking the TER is crucial in order to determine whether the increase in expenses is proportional. Ideally, the TER should decrease over time as the business becomes more efficient.
This is an invaluable benchmark not only to use internally, but can also compare performance to competitors. If your company’s TER is much higher than a competitor of similar scale in the same field, chances are that you are overspending on expenses.
TER is equally a key metric for third parties considering investing in your business. If the TER fluctuates significantly, this could signal volatility in the business and be determined as an investment risk.
Managing Total Expenses
Whether you use dedicated software or manage your own spending, it’s vital that your company manages expenses efficiently.
If you have the accounting resources available, you might try the Zero Based Budgeting method (ZBB). The principal of ZBB is to consciously allocate every dollar towards one of the company’s set goals. These goals should be reassessed on a regular basis to make sure each cost is necessary and useful.
Another method to eliminate unnecessary spending simply requires a set of highlighters. Print out the company’s monthly credit card statement, and identify each charge. Different colours can be used for different categories such as marketing, overhead, and development, and tallied in a spreadsheet for an overview of where exactly your money is going. This process will also help identify mistaken charges such as a double-booked hotel room or a card payment being deducted twice.
Dedicated phone applications are a great way to track your cash expenses when you’re out and about. Some bookkeeping software will even integrate directly with your apps.
No matter which method you choose, there’s no excuse not to track your total expenses. The information you can gather will be invaluable to your business: create smarter budgets, see more accurate projections, eliminate unnecessary costs etc. Time spent managing expenses will pay for itself.
If you’re growing a SaaS or subscription business, you should be using Baremetrics. Start a free trial today.
