When I work with clients on cost allocation and profitability studies it is not very uncommon that, yes even financial, people ask me about the difference between cash out, expense and cost. Therefore, I decided to spend some words on this. At first instance the words seem to refer to the same thing, but they are not. Especially the difference in meaning between expense and cost is not common in many languages. But let me start with comparing cash out versus expense & cost.
Cash out is the simplest one that everyone can relate to. This means that money has been spent. In many cases cash out is also an expense and cost. You can think about paying salaries to employees, paying monthly rent, buying an airplane ticket, etc. Money is spent on resources that are consumed/used to produce, sell and deliver products or services.
In certain cases, cash out is not directly treated as an expense or cost. When you buy raw materials for instance they might not be consumed directly in production. In that case you spend money but what you get back is inventory of raw materials. So basically, you have exchanged money, an asset, for inventory, also an asset. At the time of purchase nothing is booked yet as an expense or cost as it has not been consumed in the production process.. The difference with rent, salaries, lease etc. is that those services are ‘perishables’. They are consumed directly and therefore they need to be recorded as an expense directly.
Another example of cash out that is not considered directly as an expense, at least for 100%, are accruals and provisions. Think about an insurance premium that is paid on July 1 for the next 12 months. To report proper results in every month/quarter/year you need to break down the payment in 12 equal portions and recognize a portion in every month as an expense. At the time of the cash out transaction only 1/12 is recognized as an expense. On the flip side, provisions, you can think of building up a provision for large maintenance that needs to happen every 5 years. You book your expenses, 1/5 of the total, every year but your cash out is only once every 5 year when you do the actual maintenance. Similar examples in this category are long term investment, capitalization of large projects, etc.
Lastly, cash out that will never be recorded as an expense or cost is for instance repayment of loans. This is not to be confused with paying interest.
In my next post I will elaborate on the difference between Expense and Cost.
