A non-cash expense is just what it sounds like: a cost your business doesn’t pay for in cash. Also called non-cash charges, non-cash expenses include things like depreciation, stock-based employee compensation, and bad debts. Non-cash expenses reduce your business’s net income and net worth, so it’s important to make sure you’re accurately recording and reporting them.
Why Record Non-Cash Expenses?
While not all businesses are required to record non-cash expenses on their income statements, doing so gives you a more accurate picture of the long-term financial health of your business. For example, a rental car business might be making money hand over fist now, but to ensure the business succeeds in the future, it should account for how much vehicles depreciate year after year. Many non-cash expenses are also tax-deductible, so keeping track of them can help your business save money.
Types of Non-Cash Expenses
Here are some of the most common non-cash expenses:
Depreciation is the amount that tangible assets, like equipment and other property, decrease in value over time. For example, imagine your business owns equipment that was originally valued at $15,000 but depreciates in value to $12,000 after the first year. In this case, the non-cash expense would be $3,000. Depreciation is usually a tax-deductible expense, but you’ll need to follow IRS guidelines when deducting it.
Amortization is nearly the same thing as depreciation, except that it applies to intangible assets like patents and trademarks, rather than tangible assets like equipment. You calculate amortization by dividing the original price of the asset by the number of years you expect it to be useful. For example, say your company bought a patent for $50,000, and you expect to use the patent for ten years. The patent’s amortization would be $5,000 per year ($50,000 ÷ 10 = $5,000).
Resource depletion refers to the decrease in the value of natural resources, such as timber, oil, or minerals, as they’re extracted from the earth. For example, if you own a coal company, you’d need to account for your mining property losing value over time as coal is extracted.
Many companies give their employees stock options as a reward or incentive for working there. This practice is called stock-based or share-based compensation. To calculate the stock-based compensation expense of a company, you multiply the number of stock options issued to employees by their fair market value.
For example, if your company issues 100 stock options to employees and the fair market value is $10 per share, the total stock-based compensation expense would be $1,000. If there’s a vesting period—a period of time that employees must work at the company before they can claim their stock options—the total expense is divided by the number of years of the vesting period. In our example, if the vesting period is two years, the stock-based compensation expense would be $500 per year ($1,000 ÷ 2).
Provision for bad debt
If you make sales on credit, you run the risk of customers not paying you the full amount (or at all) for the goods and services they’ve received. The money that goes unpaid by customers is called bad debt, and it’s another non-cash expense. Since it’s often impossible to get an exact figure for bad debt, most businesses estimate the amount of bad debt they will have during an accounting period.
For example, if you run a furniture store where you allow customers to pay in monthly installments, you might estimate that your sales revenue will be 10% lower than the accounts receivable amount due to bad debt. If the accounts receivable amount is $120,000, your provision for bad debt would be $12,000 (10% of 120,000).
How Do I Record Non-Cash Expenses?
In order to properly record non-cash expenses, you need to know the difference between an income statement and a cash flow statement. An income statement is a financial report that shows the net profit or loss of a business during a set period of time. A cash flow statement, on the other hand, shows the cash flow of the business: how much cash is coming into and out of the business over a period of time. Non-cash expenses affect net income but not cash flow.
When you record non-cash expenses on an income statement, you’ll list non-cash expenses alongside all other business expenses. To calculate net income, you subtract all business expenses from total revenue. However, when creating a cash flow statement, you add non-cash expenses back onto your net income.
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