When running a business, budgeting, tax planning, and the tracking of business spending can pose great challenges for management. However, paying close attention to cash flow and business cost will enable companies to ensure they are on a growth trajectory.
Every business incurs expenses, ranging from rent, utility bills, equipment maintenance to inventory purchasing and handling costs. Large and small business owners need to keep a watchful eye on all of these factors to avoid losses and optimize their spending habits.
Types of Business Expenses
All businesses incur some form of expenses when operating. There are even set guidelines businesses can follow when reporting their expenses. The Internal Revenue Code explicitly states that businesses are allowed to report any expenses that are deemed ordinary' and necessary.'
Ordinary expenses refer to industry-acceptable expenses that are most commonly or frequently used within the industry. Hiring staff to manage a shop is a common ordinary expense and one that is used by the majority of businesses.
Necessary expenses are incurred to keep business operations running smoothly. In other words, the necessary expenses are ones that are both essential and appropriate to ensure that the company is able to survive. However, these expenditures can often be viewed as highly subjective. What one business owner may find vital may be viewed by others as unnecessary.
Understanding the differences between ordinary and necessary expenses is important in the context of taxation. An expense that can be legally classified as both ordinary' and necessary' are expensable and are subject to tax deductibles. Thus, for an expense to be tax-deductible, the business owner must prove that the expense was both ordinary and necessary.
An example of a business expense that is both ordinary and necessary is the mailing out of marketing materials, such as a brochure, flyer, newsletter, Christmas card, etc. Promotional materials are often mailed out by many businesses and are quite common among certain industries. It can also be seen as a necessary expense as it is a way of targeting new consumers and improving customer service.
Here are some of the more common business expenses that are both ordinary and necessary and thus, are fully tax-deductible.
- Credit card fees
- Training for employees
- Wages for employees
- Benefits programs of employees
- Equipment cost and rentals
- Interest paid
- Office/Store supplies
- Building lease
- Maintenance and repairs
Efficient and Optimized Inventory Management
Some businesses and industries must rely on having inventory or stock on hand in order to meet the demands of customers. However, increasing business spending on more inventory than a business actually needs can significantly put a drain on cash flow. This is why it is incredibly important for businesses to limit business spending with proper inventory management.
Businesses that deal with inventory need to ensure that they have efficient and optimized inventory management in place. For many companies that actively track inventory costs, a standard rule of thumb suggests businesses should spend no more than 20-30% of their business expenses on inventory. Having an efficient and optimized inventory management system will ensure that companies are within this safe range and that all business spending is under control.
On top of having a robust inventory management system in place, there are also a handful of other ways business owners can reduce inventory-related costs.
1. Track inventory costs - When tracking the total expenses relating to inventory, it can go far beyond the purchasing costs. Some of these additional expenses include the cost of capital, deterioration, taxes, and insurance, administrative costs, and depleted stock cost.
2. Improve the ordering process - When it comes to managing inventory, maintaining an efficient ordering process plays a large part. This means having a proper system set up to quickly manage orders and access customer data (i.e. delivery address). Having this system in place will ensure business owners know how much inventory they'll need in the warehouse so all customer orders are delivered on time.
3. Handle excess inventory - A common sore spot for business owners is when they simply end up purchasing too much inventory. Not only will this lead to additional purchasing and holding costs, but it can significantly harm a business' bottom line and affect the profitability of the establishment. However, there are a few tips that can help to reduce excess inventory-
- Trade inventory with competitors who may need the excess products - This is a great way for businesses to offload stock they don't need at the moment for inventory they are short of.
- Sell the excess inventory to a liquidator - This may not be the most ideal option for businesses since they will have to sell the inventory at a discount. However, if a business is desperate to increase cash flow and limit storage costs, this may be a viable option.
4. Use technology to optimize operations -
- Donate excess stock - Donating the excess inventory will, unfortunately, force a business to eat the costs of the excess material. However, in certain situations, this can be a great way for a company to build goodwill within the community and gain positive publicity.
In a world of rapid technological advancements, many companies utilize technology as a means to optimize inventory management. Companies will often use inventory ordering software to automate the stock replenishing and purchase order
processes. This software can also help companies monitor inventory volumes and maintain a safe level to keep in warehouses, cutting down on inventory-related expenses.