Not all expenses that are listed on the income statement will result in the exchange of cash.
The concept of non-cash expenses may seem foreign to those outside of the accounting department. However, they play a key role in determining a company’s bottom line and overall financial positioning.
Continue reading below as we provide a definition of non-cash expenses, explore some of the common examples, and describe their importance in a business’s finances.
What are non-cash expenses?
Non-cash expenses are business costs recorded on the income statement that don’t require a cash payment during the same period. While they reduce a company’s net income, they don’t directly impact cash flow.
Key characteristics of non-cash expenses
- Recorded but not paid now: Logged on the income statement to match expenses with the revenue they generate, even if the cash was paid in a prior period or will never be exchanged.
- Affects profit, not cash: Reduces net income but doesn’t directly lower the company’s cash balance or operational cash flow.
- Adjustment in cash flow statements: Added back to net income on the statement of cash flows to show true cash generated during the period.
Common examples of non-cash expenses
To better understand what non-cash expenses are, here are some common examples that businesses may encounter:
- Depreciation: A reduction in an asset’s value over its useful life due to wear and tear or obsolescence.
- Amortization: The gradual reduction in value of an intangible asset over its useful life.
- Stock-based compensation: The cost of equity that an employee receives in the company, which doesn’t result in a cash payment.
- Unrealized losses: The assessed decrease in an asset’s value before an actual sale is made.
- Goodwill impairments: The decrease in value of goodwill, which doesn’t involve a transfer of cash.
How to track non-cash expenses
Non-cash expenses are reported on the income statement. Despite not requiring an actual transfer of cash from the business bank account, they still impact the company’s net income in the current accounting period.
For instance, higher non-cash expenses will result in a lower net income on the profit and loss statement. But, when preparing the cash flow statement, these costs will be added back when calculating the operating cash flow for the period.
Cash expenses vs. non-cash expenses
As the terms may reveal, cash expenses are costs that involve an actual cash outflow, while non-cash expenses impact the company’s net income, but don’t require any cash payment.
Some of the common non-cash expenses are laid out above. To compare, these are some of the frequent cash expenses that are found on a business’s income statement:
- Salaries and wages
- Rent payments
- Utility payments
- Interest payments
- Raw materials purchases
Why are non-cash expenses important?
Non-cash expenses may not have a direct effect on a company’s cash positioning. However, they are not inconsequential to a company’s financial positioning. Here’s why tracking and reporting non-cash expenses accurately is important:
Accurate financial picture
A company needs to account for non-cash expenses to ensure they have an accurate picture of its financial standing. Even if the expense is not associated with a transfer of cash, it’s still representative of the cost of doing business.
Plus, to be in accordance with the matching principle, teams must record expenses (including non-cash ones) in the same period as the revenues they help generate. For instance, the depreciation expense for a piece of machinery needs to be reported during the same period that it was used to generate sales.
Tax implications
To reiterate, non-cash expenses are recorded on the income statement and reduce the net income in a given period.
As such, many non-tax expenses reduce a company’s taxable income. This result is quite favorable, as it creates a tax benefit without impacting the company’s cash flows.
Cash flow analysis
In preparing a cash flow statement, non-cash expenses are an essential component that helps companies understand how cash actually moves in and out of the business.
Net income provides just one snapshot of a company’s financial standing. However, it doesn’t tell the full story of the company’s cash positioning. Non-cash expenses must be added back to the net income figure to find the company’s operating cash flow.
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Frequently asked questions
How to record an expense if no cash is leaving the business?
If a company incurs an expense that doesn’t require cash to leave the business, it’s considered a non-cash expense.
How do non-cash expenses affect a business's profitability?
Non-cash expenses are recorded on the income statement just like cash expenses. As such, they do have an inverse relation with a company’s profitability. All things being equal, the higher the non-cash expenses a company reports, the lower the net income will be.
How should non-cash expenses be presented on the income statement and cash flow statement?
Non-cash expenses appear on the income statement alongside other cash expenses. When using the indirect method to prepare the cash flow statement, non-cash expenses, such as depreciation and amortization, are added back since they have no impact on a business’s cash balance.
What role do non-cash expenses play in accrual-based vs. cash-based accounting?
Non-cash expenses are recognized under accrual-based accounting in the period that they were incurred, even if no cash is exchanged. Under cash-based accounting, accountants are concerned with transactions that affect the cash balance, so non-cash expenses are typically not considered.
How do non-cash expenses influence financial ratios (e.g., EBITDA margin, ROA, ROE)?
Non-cash expenses can impact certain financial ratios by influencing a company’s net income. Ratios that include cash earnings, like the EBITDA margin, do not consider non-cash expenses. However, ratios that are calculated using a company’s net income, like return on equity (ROE) or return on assets (ROA), will be lower due to the inclusion of non-cash expenses.
How to explain the impact of non-cash expenses?
Non-cash expenses decrease a company’s net income under accrual-based accounting. They are also used to calculate a company’s operating net cash flow using the indirect method.
