Business expenses FAQ: Expense categories and approvals

Are your business expenses working for you or against you? Many small business owners wrestle with various expense types, each carrying unique implications for their financial statements and tax returns. Poorly managed business expenses could mean audits, huge tax penalties, and a nightmare for whoever’s handling the finances. But done the right way, with meticulous categorization, companies can better manage their budgets, anticipate tax liabilities, and enhance transparency.

In this article, we’ll address how to categorize business expenses, provide practical steps for categorization, highlight potential challenges, address expense approvals, and explore why effective categorization is vital for any business looking to thrive. Let’s dive in. 

What are business expense categories? 

Business expense categories help companies organize and track their spending. It’s like color-coding your closet but with numbers. These categories typically include operating expenses, capital expenses, cost of goods sold, administrative expenses, and marketing expenses. 

20 common categories for business expenses

Now, let's look at some common expense categories for business in this (non-exhaustive) list of deductible business expenses.

1. Office supplies and equipment: Items like paper, pens, and computers fall under this category. These are part of operating expenses. 

2. Marketing and advertising: This encompasses all costs related to promoting your business, like social media ads and traditional marketing methods.

3. Travel and entertainment: This category includes business travel expenses, client meals, and entertainment costs.

4. Professional fees and services: Costs for professional services from accountants, consultants, and legal professionals belong here.

5. Salaries and wages: Employee compensation, including bonuses, should be tracked in this category.

6. Rent and utilities: Costs of leasing office space and utility bills, like electricity and water, go here.

7. Taxes and licenses: This expense category covers business-related taxes and any necessary licenses or permits, like a liquor license if your restaurant sells alcohol. 

8. Continuing education: Expenses for employee training, workshops, or courses that aim to improve skills or knowledge are categorized here.

9. Insurance: This includes premiums for liability, health, property, and other necessary business insurance.

10. Maintenance and repairs: Costs associated with maintaining and repairing facilities and equipment should be tracked in this category.

11. Research and development (R&D): These are expenses incurred for innovation, product improvement, or new product development projects.

12. Postage and shipping: These are costs related to sending products, packages, or correspondence through mail services.

13. Client relations: This category involves investment in customer satisfaction, including feedback systems, support services, and loyalty programs.

14. Technology and software: Expenses for software subscriptions, licensing, and hardware necessary for business operations go here.

15. Depreciation: This business expense category is the regular deduction of the cost of tangible assets over time, which reflects their gradual loss of value.

16. Employee benefits and healthcare: This category covers contributions to health plans, retirement setups, and wellness programs.

17. Bad debts: This category includes any debts determined to be uncollectible. Tracking bad debts enables businesses to accurately represent their financial position.

18. Interest expense: If your business has loans, the interest paid on those loans is deductible. 

19. Bank fees: These are charges from your bank, including overdraft fees, monthly maintenance fees, and annual fees for business credit or corporate cards.

20. Miscellaneous expenses: Any other business-related expenses not fitting into the above categories can be placed here.

How to effectively categorize business expenses

As you can see, there are a lot of business expense categories – just about everything has a category! But why the need for such a long list? Specific categorization of your business expenses ensures you can easily track spending, identify areas for cost savings, and smoothly prepare for audits and tax filings. Now, let’s look at some ways to do that.

Identify and list all business expenses

First, identify and list all your business expenses, such as office supplies, travel expenses, and other deductible business expenses. Create a comprehensive list that includes recurring costs and one-time purchases. This might mean reviewing bank statements, business receipts, and invoices.

Use a consistent categorization system

Consistency is the key to everything, especially when it comes to business expense categories for taxes, which is why it’s so important to establish a set of standard categories. Stick to these basic minimum expense categories to ensure clarity and uniformity across your company’s financial records. 

Utilize accounting software and other automation tools

Furthermore, leverage accounting software or other expense tracking tools to automate the categorization process. Tools like QuickBooks and Xero offer features like receipt scanning and automatic expense categorization, saving time and reducing human error risk. Platforms like Expensify offer both default and custom categories, offering a great baseline to get started while ensuring the level of organization fits your needs. Naturally, using tools that help you automate the process allows for more accurate and efficient tracking of business expenses for taxes.

Regularly review and adjust categories

Finally, regularly review your expense categories to ensure they align with your business activities. Modify categories as needed to accommodate new types of expenses or changes in business operations. An ongoing review process helps to keep an organized expense management system, making it easier to write off business expenses.

Approvals and control: Ensuring compliance and accountability 

Establishing a robust system for expense approvals is crucial for maintaining financial integrity within your business. Proper oversight helps prevent unauthorized spending (or expense fraud) and ensures all expenses are aligned with your company’s budget and strategic goals. 

What is expenditure approval? 

Expenditure approval is a process within an organization that governs how spending is managed and authorized, like a company’s travel policy, for example. It typically involves a structured workflow where requests for funds or reimbursements are reviewed and authorized by designated individuals, such as managers or finance officers before they happen.

What is an expense approval process? 

The importance of a robust expenditure approval process can’t be overstated. With an effective expenditure approval system, businesses can better manage their cash flow, optimize budgeting, and ultimately drive financial success.

Here’s an example of what the process looks like: 

1. Submission: Employees or departments submit requests detailing the expenditure's purpose, the amount required, and any supporting documentation. This initial step lays the groundwork for transparent financial management.

2. Review process: Once a request is submitted, it undergoes a review process. Approvers assess the necessity, relevance, and budget impact of the request expenditure. This review ensures that spending aligns with the organization's financial policies and goals.

3. Approval or rejection: The expenditure request is either approved or rejected based on the review. The decision is communicated to the employee or department that made the request. If approved, the funds are allocated according to the company’s financial protocols. 

4. Documentation and reporting: All approved expenditures are documented for record-keeping and compliance purposes. This documentation is essential for financial audits and helps maintain a transparent overview of the company's spending habits.

5. Monitoring and control: Advanced expenditure approval systems, such as those offered by platforms like Expensify, provide enhanced monitoring capabilities. These systems can flag out-of-policy spending, automate workflows, trigger alerts for unusual expenditure patterns, and set spending limits. This level of control helps organizations prevent overspending and ensure proper use of funds.

Potential challenges in categorizing business expenses

Watch out for these potential challenges when it comes to categorizing business expenses. 

Misclassification of expenses

Misclassifying expenses is a common issue that can lead to inaccurate financial statements and potential tax penalties. For example, when business travel costs are accidentally categorized as personal travel, it can skew reports and lead to incorrect tax filings. 

Changes in tax regulations

Tax regulations aren’t static; they evolve, impacting how businesses report their activities. Thanks to changes in tax laws, a deduction that was valid one year ago might not be allowed in the current year. Staying updated with the latest IRS guidelines is vital for ensuring business expenses for taxes are categorized correctly, helping to avoid incorrect business tax write-offs.

Complexity with multi-purpose expenses

Multi-purpose expenses are challenging to categorize because they don't fit neatly into one category. For instance, a smartphone used for business calls and personal use must be divided appropriately, especially if you’re writing off business expenses on your personal taxes. By keeping detailed records, small businesses can better allocate such expenses, ensuring they meet the requirements for tax-deductible expenses and optimizing their business deductions.

Best practices for managing business expense categories

Once you have everything in place for expense categories and approvals, how can you streamline financial operations and stay tax-compliant? Glad you asked! The following are some other best practices to consider. 

Keeping clear records

Maintaining clear and organized records of business expenses is vital to facilitate easy tracking of deductible expenses and provide solid documentation for audits. Use digital tools and software to keep all receipts and records in one accessible location, ensuring no important details are overlooked.

Involving an accountant or financial advisor

Consulting with an accountant or financial advisor can provide valuable insights into managing business expenses and can give you tax tips for your small business. These professionals can guide you in understanding complex tax-deductible expenses and help you categorize expenses to maximize all possible tax write-offs for your small businesses.

The impact of effective business expense categorization

Just how important is it to implement strong financial practices, such as effectively categorizing business expenses? It goes way beyond identifying all your small business tax write-offs. 

Budgeting and forecasting

Effective categorization of business expenses can be a huge help in budgeting and forecasting. When you classify expenses correctly, you can analyze spending patterns over time, allowing for smarter financial decisions. For example, if one category, such as employee training, consistently exceeds budget expectations, it may indicate a need for reevaluation of training programs or a discussion on optimizing expenses in other areas.

Better communication

Proper categorization also facilitates better communication between departments. When employees understand how expenses are categorized, they can accurately record and report their spending. This promotes accountability and ensures everyone is aligned with the company’s financial goals.

Being audit-ready

Moreover, well-categorized expenses streamline the process during audits or reviews and reduce the stress involved. Whether an internal review or an external audit, presenting your financials in an organized way showcases professionalism and adherence to best practices. 

Becoming attractive to investors 

Accurate expense categorization can enhance your business’s ability to secure funding or investment. Investors often scrutinize financial health, and having clear, categorized expense reports can demonstrate responsible financial management. It indicates your business isn’t just about revenue generation but also about careful oversight of operational costs, which is a sign of a well-run organization. That’s where using tools that can automate the process of business expense categorization comes in handy.

• What are the IRS categories for business expenses?

  What expenses are deductible? The IRS provides specific categories for business expenses, including costs like rent, utilities, supplies, marketing, and travel. These categories help businesses determine what can be deducted from their taxable income, ensuring compliance with tax regulations. Understanding these categories can help you accurately report your expenses and identify tax-deductible costs.

• How can you deduct business expenses?

  Deducting business expenses must be ordinary and necessary for your trade or profession. Start by categorizing expenses under appropriate heads, such as office supplies, travel, and insurance. Ensure that you have proper documentation and receipts for all expenses. Then, use these categorized expenses when filling out your tax forms to maximize your deductions.

• How do you categorize business expenses for taxes?

  Categorizing business expenses for taxes involves assigning each expense to the correct category according to the IRS guidelines. Common categories include office expenses, travel, utilities, and advertising. Maintaining organized and precise records throughout the fiscal year aids in correct classification, promoting accurate tax submissions and potential tax savings.

• What are the different types of business expenses?

  There are three main categories of business expenses: operating expenses, capital expenses, and direct or indirect expenses. Understanding how to categorize expenses for a small business is crucial for effective financial management and maximizing business tax deductions. Proper categorization helps track cash flow and ensures compliance with tax regulations, especially when writing off business expenses.

• What are operating expenses?

  Think of operating expenses as the day-to-day costs that keep your business running. They’re essential for maintaining business operations, usually from a business’s operating account. These include office supplies, rent, utilities, and salaries. They’re immediately deductible, making them important for calculating net income and budgeting expenses.

• What are capital expenses?

  Unlike the day-to-day, short-term function of operating expenses, capital expenses are long-term investments in the business, such as purchasing equipment, machinery, or property. These aren’t immediately deductible but are capitalized, meaning they’re expensed over the asset's useful life.

• What are direct vs. indirect expenses?

  Direct expenses are costs tied directly to producing goods or services, such as raw materials and labor. Indirect expenses include overhead costs like utilities and rent, which are not directly tied to production but still necessary for operation. Both types are essential for financial reporting, accurately assessing profitability and efficiency.

• What is not a business expense?

  Not all expenditures qualify as business expenses. Personal expenses, such as travel or non-business-related meals, can't be written off. Additionally, any costs that aren’t directly tied to the operation of the business, like personal gifts or fines and penalties incurred for legal violations, also fall outside the realm of business deductions.

• What items are 100% deductible?

  Items that are 100% deductible are typically expenses considered ordinary and necessary for the operation of your business. These include office supplies, business-related meals (up to 50% deductibility in certain situations), membership dues for professional organizations, and educational expenses that maintain or improve skills related to your business. Additionally, business insurance, legal and professional fees, and advertising costs are generally fully deductible.

• What is the meaning of expense approver? Who should approve expenses?

  An expense approver is responsible for reviewing and authorizing business expenditures to ensure they align with company policies and budget constraints. This role is typically filled by a manager or supervisor who comprehensively understands the organization's financial practices and governance. Expense approvers should have knowledge of the types of expenses that are categorized as either direct or indirect, ensuring that only legitimate business costs are approved. Doing so helps maintain financial discipline, prevent unauthorized spending, and support accurate financial reporting, which is crucial for operational efficiency and tax compliance.

• What is the expense approval limit?

  The expense approval limit varies by organization and is typically set to ensure effective financial management and oversight. This limit defines the maximum amount that an expense approver can approve without requiring additional oversight or authorization from higher management or finance departments. For instance, some companies may set limits based on the role of the individual approving the expense. Lower-level employees might have a limit of a few hundred dollars, while managers may have a limit in the thousands.