Cost of Doing Business Definition: Everything You Need to Know
The cost of doing business definition is any expense a business incurs while in the process of conducting business. A cost of doing business could be a direct cost, like raw materials, or an indirect cost, like building security.3 min read
The Cost of Doing Business
The cost of doing business definition is any expense a business incurs while in the process of conducting business. A cost of doing business could be a direct cost, like raw materials, or an indirect cost, like building security. Regardless of type, such costs must be considered carefully by managers, business owners, and anyone involved in running a company, since the amount of such costs will play a large role in determining if a company is profitable or not.
Calculating the Cost of Doing Business
Understanding the cost of doing business is essential to running a business properly. This cost depends on many factors, including the costs of services and goods, compliance with regulations, and interest rates for taxes and borrowed funds. The lower a business’s overall cost, the easier it will be for it to operate, pay taxes, and hire employees, if necessary.
Figuring operational cost can be done by using the following equation: non-reimbursable expenses + desired salary (yielding total annual costs) ÷ number of billable days = the cost of doing business. If you are starting a business, it is also important to remember to factor in:
- Startup costs.
- Registration and licensing costs.
- Rent costs.
- Employee salary costs.
- Advertising costs.
Aside from startup and registration costs, such costs would most likely be incurred by a business in any event, but new business owners may be more likely to neglect factoring them in. New business owners may also be more concerned with reducing their costs. Some cost-cutting possibilities include leasing or hiring equipment rather than buying and avoiding unnecessary expenses by finding multiple uses for labor, computer systems, or production facilities.
Business expenses are the economic costs a business must incur in order to operate and, hopefully, make revenue. Common business expenses include:
- Payments to suppliers.
- Factory leases.
- Equipment depreciation.
- Employee wages.
Some business expenses may be tax deductible, but the IRS has strict rules regarding which expenses a business can claim a deduction on. The IRS rules for deductibles state that a deductible business expense must be both necessary and ordinary. Necessary meaning that the expense helps the business earn income, while ordinary means that such an expense is accepted as common to the business’s particular industry. Thus, business owners cannot claim personal expenses as necessary expense deductibles, nor can outlandish purchases be justified as deductible in the name of business.
Larger, long term expenses are known as capital expenses, and they may include:
- Business startup costs.
- Real estate.
- Construction and building improvements.
Such expenses may also qualify for tax deductions, but they must be written off over a period of years, and this is subject to a schedule the IRS has that dictates how much of the capital expense a business may write off annually. The number of years a capital expense may be written off and for how much varies from expense to expense.
Business expenses may be divided into two broad categories, one of which is product expenses. Product expenses relate to the cost of production, which may either be the direct or indirect costs associated with manufacturing a product and getting it ready for sale. Such costs consist of labor, materials, and overhead, and these can further be divided into two groups: conversion costs and prime costs. Conversion costs relate to converting raw materials into a final product, while prime costs are the materials themselves plus labor. The sum of all such costs is the total cost of producing a product.
Period expenses are the other category of business expenses, and they are any costs unrelated to production costs, which may include advertising, salaries, and office supplies, for example. These costs will appear as expenses in the income statement rather than inventory on the balance sheet. If one expects a period costs to create an economic benefit for more than one year, then such a cost can be capitalized and written off through depreciation across a number of years, instead of being expensed in one year.
Ultimately, when business decisions are being made, you will want to include the cost of doing business in your calculations. If you need help understanding the cost of doing business definition, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.