Expense analysis

An expense in accounting is the money spent, or costs incurred, by a business in their effort to generate revenues. Essentially, accounts expenses represent the cost of doing business; they are the sum of all the activities that hopefully generate a profit.

A cost-benefit analysis is a systematic process that businesses use to analyze which decisions to make and which to forgo. The cost benefit analyst sums the potential rewards expected from a situation or action and then subtracts the total costs associated with taking that action. Some consultants or analysts also build models to assign a dollar value on intangible items, such as the benefits and costs associated with living in a certain town.

An expense is defined in the following ways:

• Depreciation expense, which is a charge to reduce the book value of capital equipment (e.g., a machine or a building) to reflect its usage over a period.
• A prepaid expense, such as prepaid rent, is an asset that turns into a cash expense as the rent is used up each month.
• Office supplies use up the cash (asset).

Before building a new plant or taking on a new project, prudent managers conduct a cost-benefit analysis to evaluate all the potential costs and revenues that a company might generate from the project. The outcome of the analysis will determine whether the project is financially feasible or if the company should pursue another project.

In many models, a cost-benefit analysis will also factor the opportunity cost into the decision-making process. Opportunity costs are alternative benefits that could have been realized when choosing one alternative over another. In other words, the opportunity cost is the forgone or missed opportunity as a result of a choice or decision. Factoring in opportunity costs allows project managers to weigh the benefits from alternative courses of action and not merely the current path or choice being considered in the cost-benefit analysis.

A cost-benefit analysis (CBA) should begin with compiling a comprehensive list of all the costs and benefits associated with the project or decision.

The costs involved in a CBA might include the following:

• Indirect costs might include electricity, overhead costs from management, rent, utilities.
• Direct costs would be direct labor involved in manufacturing, inventory, raw materials, manufacturing expenses.
• Intangible costs of a decision, such as the impact on customers, employees, or delivery times.
• Cost of potential risks such as regulatory risks, competition, and environmental impacts.
• Opportunity costs such as alternative investments, or buying a plant versus building one.