As a startup founder, you have to become familiar with basic accounting concepts. In this article and the corresponding video, we discuss how to categorize various cash expenses from your Income, or Profit & Loss, Statement properly.
Not All Costs Are Cash Costs
Not all costs are cash costs. You may wonder why you would have non-cash expenses on your P&L Statement. That is because the more you deduct, the fewer taxes you pay, and the IRS allows you to make certain deductions that do not have an associated cash outflow.
One of such non-cash deductions is a depreciation expense. A depreciation expense is an annual non-cash cost of using a tangible fixed asset you already paid for in cash. A tangible fixed asset is an asset such as a computer, furniture, or any other physical asset.
Types Of Cash Costs
Of course, most of the startup expenses are cash costs or costs which you DO need to pay. These costs are split into four categories: variable, fixed, financing, and tax.
Variable costs are those that vary with the level of sales. Examples of such costs include the cost of raw materials and packaging costs. It’s important to understand that you only have those costs when you have sales. If you have no sales, your variable costs are zero.
Fixed costs are your operating costs and do NOT vary with the level of sales. This means you have to pay them when you make millions in sales AND when you make zero in sales. Examples of such costs include marketing, salaries, bookkeeping, rent, etc.
Just because the costs are fixed does not mean that they are constant. The costs can increase or decrease over time, based on the company’s strategy. An example would be an employee getting a promotion and an increase in salary or an increase in rent.
Financing costs relate to you having to pay interest on your debt. So, these costs are only present if you have debt. If you do not have debt, you will not have financing costs.
Tax costs are your cash obligations to the IRS. If you have a negative income, you may not have to pay anything or very little. Further, you may be able to carry your losses forward to future years so that you limit the amount of taxes you have to pay in future years as well.
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