What is Expenditure

Introduction to expenditure
Whether you are running a business or a non commercial or a not for profit enterprise, certain capital and revenue expenses are bound to be there. There will be some pre-operative expenses before starting any business which have to be maintained carefully for claiming later as per local income tax laws. Than, you need the minimum basic 'Capital' for the start up for investing in plant, machinery, land and people. This is often called as the 'Paid up Capital'. In 'Capital' you have what is called as 'Authorized capital' and 'Fully paid up capital'. We have covered these terms in our article titled 'What is a balance sheet'. If you are in service business, you need to invest in office, communication equipment, computers, necessary infrastructure and people to provide the service.
A service industry always requires lesser capital investments compared to a manufacturing enterprise. This is the reason you will find many people starting their own service business. Sometimes, this is offset by high people costs and you often find giant service companies in developed countries outsourcing their work to low cost economies like India, to maintain their competitive edge.
In manufacturing, it is not new. It has always existed in the past. It has accelerated and mostly shifting to China. Plant and Machinery depreciate over a period of time and is a tax deductible expense as per most local IT laws. However, it is not so with people. Their demands will constantly increase and as a result service companies will have to be very careful on this account. This forces the service companies to hire 'temps', but leads to industrial relations, union and labor problems for the management. However, that is not the subject of discussion in this page.
Once your plant, equipment and infrastructure are in place, you need to have the necessary working capital to produce what you have to offer, either some product or service. Many businesses look for some funding of both initial capital and working capital from financial institutions. This means you will incur some initial expenses, both capital and revenue, before you start earning and making a profit. Such expenses are called expenditure in business parlance. Expenditure comes first. Income and Profit may or may not follow later. We all need to eat and meet the basic necessities of life and that is expenditure. Hence it is necessary to understand expenditure and control it. It is essential to understand that all expenditures will have to be classified. Classifying expenditure enables one to report correctly within the financial structure and control it. Whether you are making a large profit or a small one does not matter, you have to control all form of expenditure. The hallmark of a good business is how it controls expenditure prudently.
Capital or Revenue ?
All expenses towards buying land, buildings, plant, equipment, computers and furniture will come under "Capital" expenditure. If you buy an inappropriate or wrong machinery for your production process, than you may not be able to make and sell your product, in which case it is disaster of the greatest magnitude. If your equipment is too small than you may not be able to meet the future demand. Alternatively, if your installed capacity is too high, you may be underutilizing the capacity and as a result, the cost of production per unit will be high, because of higher fixed costs and you will find it uneconomical to market it. If you buy the land in a remote place, just because it is cheap, you may find that the cost of transportation of both raw materials and finished goods is very high and you are not competitive. Many states and countries offer what is called as tax incentives and many other concessions for people to invest in backward and remote areas. You may find that such incentives have no meaning in the long run and end up with all the disadvantages. Hence all capital expenditures are of strategic nature and will have to well thought out. Your business plan must take care of all these aspects. This should cover the investments, risks and expected returns.
Government Departments, Efficiency and Expenditure:
The government departments and civil servants exist to serve the people. The expenses and salaries they incur come out of the tax payer’s money. They are neither a commercial enterprise and nor are they in service for profits. It makes it more mandatory for them to keep the expenses in control. All the Provincial Commissioners and senior officers are allotted a luxury S - Class Mercedes Benz with a chauffeur. Kenya has the maximum number of Mercedes Benz's in the world compared to the size of the population. The government departments in Kenya are over staffed and operate at a very poor efficiency. Many of the staff is poorly trained. Having poorly trained people is basically a drain. The other day I was at the Kenya Revenue Authority (KRA) head office to pay my VAT dues. There were hundreds of people. After spending one hour in the queue, when my turn came, I was told to go to some other floor and queue to pay it. It must be noted that I was told to join the particular queue by the man at the reception. Earlier, I had stood in another queue in a bank authorized by KRA to collect the VAT dues on its behalf, only to be told when my turn came, that I had to bring banker certified cheque or pay cash. My cheque was not good enough. After running from pillar to post for nearly 2 hours, I finally requested my banker to pay it by paying them. Luckily they did not ask for any service charges. The best part of it was that even they did not know what a bank certified cheque was ! Government departments must train its people, as otherwise their long term survival will be difficult. No government can afford to carry excess baggage.
Summary & Conclusion
Expenditure has to be well thought out and budgeted for. A penny saved is a penny earned. There are some necessary and unnecessary expenditure. Fancy cars, private parking, executive jets and fancy offices are not necessary expenditure. Secretaries, Executive Assistants, Personal Assistants and Office Assistants are not necessary. We can make the entire office practically paperless and save on internal printing and stationery requirement. While it is always prudent to control expenditure, there is some expenditure which should not be cut or reduced, even in bad times. The temptation is always to cut some of the necessary expenses in bad times. Unfortunately, this has a boomerang effect. It affects the organization in the long run. It is essential that the study of the profit impact of reduction in expenditure is undertaken before going in for expense reduction in any area.
© Copyright. August 9, 2008. Without prejudice. All rights reserved.

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