Non-Operating Expenses: What They Are & Why They Matter for Your Business
As a business owner or executive, you know that managing expenses is a crucial part of keeping your company financially healthy. While much of your focus is likely on operational costs that go into running your business day-to-day, there‘s another category of expenses you can‘t afford to ignore: non-operating expenses.
Non-operating expenses are costs that fall outside your core business activities but still impact your bottom line. Research shows that non-operating expenses account for an average of 7-10% of a company‘s total costs.[^1] For small businesses, even a few unexpected non-operating costs can mean the difference between turning a profit or ending up in the red.
In this post, we‘ll take a deep dive into the world of non-operating expenses. We‘ll cover exactly what they are, why they matter, and how you can effectively manage them to keep your business on solid financial footing.
What Are Non-Operating Expenses?
Non-operating expenses are costs a business incurs that don‘t directly relate to core profit-generating activities. Unlike operating expenses such as payroll, rent, and cost of goods sold, non-operating expenses result from secondary business activities or one-off events.
Some common examples of non-operating expenses include:
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Lawsuit settlements. If your business gets sued and has to pay out a settlement or legal fees, those costs are non-operating expenses. For example, if a customer sues your restaurant for food poisoning and you settle for $50,000, that‘s a non-operating expense.
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Losses on investments. Many companies invest in securities, real estate, or other businesses. If those investments lose value or get sold at a loss, it results in a non-operating expense. Say your company buys $100,000 in stock and later sells it for $80,000. The $20,000 loss is a non-operating expense.
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Interest on debts. If you take out loans to grow your business, the interest you pay on that debt is considered a non-operating expense. For instance, if you have a $500,000 small business loan with a 5% interest rate, the $25,000 in annual interest counts as a non-operating expense.
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Inventory write-offs. If inventory gets damaged, expires, or becomes obsolete, writing off its value results in a non-operating expense. This is common in retail, food service, and other industries dealing with perishable goods. If you own a grocery store and have to write off $10,000 in expired meat and dairy, that‘s a non-operating expense.
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Restructuring costs. Major corporate restructuring activities like mergers, acquisitions, or expansions often come with one-off costs that qualify as non-operating expenses. For example, if your business acquires a competitor and has to pay $100,000 in legal and consulting fees to finalize the deal, those are non-operating expenses.
Non-operating expenses get reported on a company‘s income statement, but usually separately from operating expenses, often under an "other expenses" category. It‘s important to note that non-operating expenses are different from non-operating income, which is money earned from secondary activities like interest or rental income.
Why Non-Operating Expenses Matter
You might be thinking, if non-operating expenses don‘t come from my company‘s core money-making activities, why should I care about them? The truth is, non-operating expenses can have a major impact on your business‘s financial health and profitability. Here‘s why they matter:
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They eat into profits. Every dollar your business spends on a non-operating expense is a dollar that doesn‘t make it to your bottom line. According to a study by PwC, the average Fortune 500 company loses 27 cents of every dollar of revenue to non-operating expenses.^2 For a small business with thin margins, even minor non-operating costs can turn profits into losses.
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They can catch you by surprise. Many non-operating expenses like lawsuits, accidents, or asset write-downs are hard to predict. If you‘re not prepared with adequate cash reserves, an unexpected non-operating expense can trigger a serious cash crunch and threaten your business‘s survival. One study found that 29% of failed startups cited running out of cash as a reason for going under.[^3]
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They influence investor and creditor decisions. Investors, lenders, and other stakeholders look closely at a company‘s profits and cash flow when making decisions. High or recurring non-operating expenses are a red flag that can scare off potential backers. A report by Standard & Poor‘s found that companies with above-average non-operating expenses are 42% more likely to face credit downgrades.[^4]
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They can conceal operational problems. Sometimes companies try to boost their operating income by shifting expenses to the non-operating category. While this accounting maneuver can make a company‘s core business seem more profitable than it really is, it‘s misleading and can backfire if the tactic gets identified in an audit. Groupon famously had to restate its finances in 2011 after the SEC objected to how it was categorizing marketing costs as non-operating expenses.^5
The bottom line is that while non-operating expenses may seem ancillary to your core business, they can make or break your company‘s financial well-being. As a business leader, it‘s essential to give them proper attention and have a plan for managing them.
Tracking and Recording Non-Operating Expenses
The first step to getting a handle on your company‘s non-operating expenses is tracking and recording them accurately. This means setting up clear systems, policies, and procedures for identifying, categorizing, and documenting every non-operating cost as it comes in.
Here‘s a step-by-step guide to recording non-operating expenses:
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Create distinct accounts. Set up separate general ledger accounts for different types of non-operating expenses, such as litigation costs, investment losses, interest expense, and so on. This will make it easier to track spending in each category over time.
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Implement clear policies. Develop written policies that spell out what qualifies as a non-operating expense and how employees should handle them. For example, you might require that any legal settlements over $10,000 get logged as non-operating expenses and that all investment activities go through the CFO for approval and recording.
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Document every expense. Establish processes to ensure that every non-operating expense gets properly documented with supporting evidence like receipts, invoices, or legal agreements. This paper trail will be crucial for financial reporting and audits down the line.
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Record costs as incurred. Generally Accepted Accounting Principles (GAAP) require that expenses get recorded when they‘re incurred, not paid.[^6] This means logging non-operating expenses as soon as there‘s a legal obligation to pay them, even if the actual cash outlay happens later. For example, if you get sued in March and settle in September, you‘d record the expense in March when the liability arose.
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Reconcile regularly. Schedule regular reviews (at least quarterly) to double check that all non-operating expenses are getting captured and recorded correctly. This might involve combing through legal records, investment statements, and vendor contracts to match them to your general ledger. Any discrepancies should get investigated and corrected promptly.
Accurately recording non-operating expenses doesn‘t just keep your business in compliance with accounting standards. It also gives you crucial visibility into where money is going so you can make informed decisions. The more robust your non-operating expense tracking, the better positioned you‘ll be to control costs down the line.
Planning for Non-Operating Expenses
Let‘s face it: you can‘t always predict when a lawsuit will hit or a natural disaster will strike your business. But that doesn‘t mean non-operating expenses have to ambush your bottom line. With some proactive planning, you can build resilience and be ready to handle non-operating costs whenever they arise.
Here are some strategies to plan for and limit non-operating expenses:
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Forecast various scenarios. While you can‘t pin down exactly what non-operating expenses will hit in a given year, you can make educated guesses. Analyze your past non-operating costs and industry trends to develop best, worst, and likely case scenarios for potential non-operating expenses. Then pressure-test your cash flow projections to ensure you could withstand each scenario.
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Build up reserves. Based on your forecasts, gradually build up a dedicated cash reserve to cover potential non-operating expenses. Most experts recommend socking away at least six months‘ worth of operating costs.^7 Having this cushion will help you avoid a cash crisis if a big non-operating expense hits.
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Tighten up processes. Put checks and balances in place to limit the risk of incurring non-operating expenses like lawsuits, penalties, or investment losses. This might include implementing strict safety protocols, creating a legal review process for contracts, or requiring multiple approvals for investment decisions.
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Invest in prevention. Some upfront investments can help you avoid costly non-operating expenses down the line. For example, regular maintenance on equipment can prevent breakdowns or product defects that lead to customer lawsuits. Thorough due diligence can stop you from acquiring a company that comes with hidden liabilities.
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Insure against risks. Work with an insurance broker to secure adequate coverage for potential non-operating risks like property damage, business interruptions, professional liability, or key person losses. Having the right insurance in place can turn a devastating non-operating expense into a manageable (or even fully covered) cost.
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Have a crisis plan. Even the best-laid plans can‘t always stop a catastrophic non-operating expense from arising. Have a written plan spelling out how your business would respond to worst-case scenarios like a natural disaster, product recall, or major lawsuit. Include clear action steps, communication protocols, and financial contingencies.
By giving non-operating expenses proactive attention, you can take a lot of the sting out of these pesky costs. No, you can‘t eliminate them entirely, but you can absolutely develop a battle plan to limit their potential damage.
Get a Handle on Your Non-Operating Expenses
At the end of the day, running a business means expecting the unexpected. Non-operating expenses may not be the sexiest part of financial management, but they play a huge role in the success or failure of your company.
By understanding what non-operating expenses are, tracking them diligently, and planning ahead, you can keep these costs from torpedoing your bottom line. The more proactive you are about managing non-operating expenses, the better positioned you‘ll be to maintain profitability for the long run.
So take an honest look at how your business handles non-operating expenses. Do you have clear policies and systems in place to log every cost? Are you budgeting for potential non-operating expenses in your forecasts? Have you built up a strong cash reserve to absorb unforeseen costs? If not, now‘s the time to up your game. Your business‘s financial future depends on it.
[^1]: Corporate Finance Institute [^3]: CB Insights[^4]: S&P Global Market Intelligence [^6]: Accounting Coach
