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How Do You Categorize Expenses for A Small Business?

How Do You Categorize Expenses for A Small Business?
Susan Guillory
Susan GuilloryUpdated August 15, 2022
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OK, you’re no accountant. But you’ve probably learned through running a small business that it’s often necessary to have at least a basic knowledge of finance and accounting. You may be clueless about certain accounting tasks, like calculating cash flow or creating a balance sheet. But it’s important that you learn how to categorize expenses for small businesses.Even if you have an accountant on your team, it’s still a good idea to familiarize yourself with your finances and especially with how to categorize them.

Why You Need to Categorize Business Expenses

Even if you work with an accountant, it may fall on you to make sure that the purchases you’re making for your business are entered into the appropriate categories in your accounting software.There are, as you’ll soon learn, certain expenses you can deduct from your revenues for the year. That can help you pay less in taxes for your business. But to know how much, you’ll need to know what you spent in different categories so that you can file your taxes correctly with the IRS.What deductible business expenses can do for you is reduce your taxable income. If your revenues last year were $250,000 but you had $50,000 in deductible business expenses, you would pay taxes on only $200,000 in revenue.Categorizing business expenses can also help you keep an eye on where you’re spending money. Running an expense report can show you at a glance where you might be overspending so you can strategize about how best to cut back.Recommended: 5 Small Business Tax Tips for Business Owners

How to Categorize Business Expenses

One good way to categorize expenses as a small business is by using accounting software like QuickBooks or Freshbooks. With programs like this, there will be some preset categories, like travel and payroll, but you may also want to add your own to keep a more detailed account of where you’re spending money.Most accounting software will connect to your bank accounts and upload your transactions. It’s still a good idea to log in every week or month and review your transactions to make sure they’re appropriately categorized.Recommended: 6 Tips for Managing Small Business Finances

What Is a Deductible Business Expense?

As part of learning how to categorize expenses for small businesses, you’ll need to understand deductible business expenses. According to the IRS, in order for a business expense to be deductible, it must be ordinary and necessary.As an example, a vehicle you use for your contracting company would be considered ordinary and necessary for your business to operate. Thus, costs related to it, like the loan and upkeep, would be deductible. But those same expenses for your personal vehicle would not qualify.

What Are the Business Expense Categories?

Anything that isn’t considered working capital or cash in your accounting software is an expense. If you learn how to categorize expenses for small businesses, your accounting will be easier. Here are a few common business expense categories.

Rent

You likely rent office or retail space for your business. You might even have an additional warehouse or storage unit. All of these should be categorized under rent.

Vehicle Expenses

As in the example earlier: if you use one or more vehicles for your business, categorize business expenses like the following as vehicle expenses:

Advertising

If you pay for advertising or marketing for your business in the form of online ads, radio spots, or even hiring a marketing consultant, these expenses should all fall under the category of advertising.

Travel Expenses

Is traveling to see clients or attend trade shows part of your business? You can deduct business airline travel, hotels, rental cars, and meals while traveling when you file your taxes. Just keep all these items categorized under travel.

Food and Entertainment

Whenever you take a client out to dinner or host an employee lunch at the office, you’re spending money on food and entertainment for your business, so categorize it as such.

Office Supplies

You spend money on paper, ink, pens, printer cartridges, and other office supplies for your business. Create a category for office supplies and make sure all these expenses fall under it.

Payroll

Whether you have full-time employees, part-time staff, or contractors, you can categorize all of their wages under payroll. This also includes employee benefits and health insurance.

Services and Utilities

This category includes things like internet service and electricity, as well as phone service for your business.

Loans

If you’ve taken out a small business loan or line of credit, you may find it helpful to have a category for your loan payments. Keep in mind: only interest on business loans is deductible on your taxes.

Taxes

While it’s not necessary, you may find it beneficial to create a category in your system for taxes that you’ve paid. Once you learn how to categorize taxes for your small business, you can easily see how much you’ve paid year to year.Recommended: What Is Business Financial Planning?

What Can I Write Off for Business Expenses for a Home Office?

But you may be wondering how to categorize expenses for small businesses that you operate from your home. For home-based businesses, you can deduct (or write off) all the business expenses already listed and a few more.When you file your taxes, you’ll have two options for how you claim home business expenses. 
  • The simplified option. If you choose the simplified option, you will be asked for the size of your office space. This number is multiplied times a prescribed rate to determine your home office deductions.
  • The regular method. Because you use a portion of your home for your office, you can deduct a portion of your home’s expenses, including rent or mortgage, utilities, internet, and home repairs. So you’ll need to track those expenses and then determine what percentage your home office used, based on its size in proportion to your home’s total square footage.

The Takeaway

It may seem like a nuisance, but taking the time to set up categories for your business expenses now can save you a major headache down the road. It can also help you pay less in taxes when you look at deductible expenses. And finally, categorizing business expenses lets you see the big picture in terms of where your company is spending money.Looking to grow your business? Compare rates for small business loans online with Lantern by SoFi and get multiple offers from different lenders in our partner network.

Frequently Asked Questions

What can you write off as a business expense?
What are the biggest kinds of business expenses?
How should I keep track of my expenses?
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Photo credit: iStock/Lyndon Stratford
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About the Author

Susan Guillory

Susan Guillory

Su Guillory is a freelance business writer and expat coach. She’s written several business books and has been published on sites including Forbes, AllBusiness, and SoFi. She writes about business and personal credit, financial strategies, loans, and credit cards.
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