Are Cash Outflows and Expenses the Same?
The purpose of this article is to shed light on the meaning of the terms: expense and cash outflow from an accounting perspective. More specifically, it discusses the similarities and differences of these terms within a business context. In addition, it uses examples in order to elaborate clearly this challenging issue for working professionals and students.
Expense: The value of the inputs (e.g. food and beverages) that are being used for revenue-generating activities.
Cash outflow: A cash payment a business makes to another entity, such as an employee, another company, the government, a shareholder, etc.
A cash outflow or payment is the same as an expense? ‘Yes’-‘No’-‘Never’ Cases.
Scenario 1: ‘No’ case
Let’s consider the following business transaction within a restaurant business. A restaurant buys in cash in June beverages for $1000. However, none of these beverages is sold during June. In a case like this, accounting will not recognize the $1000 as an expense but as a cost since by the end of that period the beverages have not been used for revenue-relating activity.
Scenario 2: ‘Yes’ case
In another case, a restaurant pays $1000 to buy beverages in June and all of these beverages are consumed by its customers within June. In this situation, all of the beverages that were consumed by the customers can be recognized as an expense, such as beverage expense or cost of beverages sold.
Scenario 3: ‘Yes’ and ‘No’ cases
In a different scenario, the business purchases beverages for $1000 in cash and only $500 of these items are sold to its customers in June and the rest remain unsold.
Accountants will report as an expense (cost of beverages sold) only the $500 that were used up by the restaurant’s customers.
Therefore, in the above examples, we can easily observe that the above cost element (beverages) may become an expense only when it’s consumed.
The remaining $500, which is unused, will be reported as an asset (inventory for beverages) and not an expense.
Scenario 4: Partly ‘Yes’ and ‘No’ cases
Consider now a hotel that buys a bus in order to give to its guests tours and pays for it $30000. Can I record this amount as an expense? The bus is a different type of asset (fixed tangible asset), which can be used more than once and for a long time period (compared to the previous 3 examples with the beverages).
Here we need to consider another accounting element which is the economic life time or useful lifetime of this asset stating the time during which the hotel may be using the bus for revenue-producing purposes.
If we assume that accounting rules states that the economic life of the bus is five years, then the hotel can record in its books the $30000 as an expense gradually and over a 5-year time period. That means it will show every year as an expense approximately $6000 ($30000/5 years). This is called depreciation expense, which shows the annual estimated use of the bus. Therefore, it will record annually a part ($6000) of the initial cash payment as an expense (see table below).
|yr 1||yr 2||yr 3||yr 4||yr 5|
|Depreciation expense (Bus)||$6000||$6000||$6000||$6000||$6000|
Scenario 5: ‘Never’ cases
There are also transactions that involve cash outflows but based on accounting rules they are never recognized as an expense. Some of these transactions are the following:
- The owner withdraws capital from the business for personal reasons – cash outflow only
- The business makes payments to the principal amount of the loan only (not the interest of the loan) – cash outflow only
- Dividends paid to the shareholders- cash outflow only
- Purchase of land (even though it’s a fixed tangible asset, it is never used up) – cash outflow only
It’s evident that the cash flow and expense can be similar or completely irrelevant within a business context from an accounting perspective and they may relate to different financial reports. Of course, the accuracy of recording expenses is another issue since in many cases they are estimated, such as in the case of depreciation which in most cases it is based on the estimated use and not the actual use of the fixed tangible assets.
Food for Thought
Is there a possibility that a business without having made a cash payment to another entity to be able to record an expense?