Interest expense is the cost incurred by a borrower for using borrowed funds. It does not include principal payments made.
Primary Implication
From an accounting perspective, the biggest challenge with Interest Expenses involves fully accounting for the Interest Expense you pay each month. Keeping a record of the interest expenses you incur and pay is a tax-deductible cost of doing business that too many fail to account for accurately.
The bigger challenge with Interest Expense is it represents never-ending Cash Outflow until the borrowed money being charge interest is paid off. All is well as long as the borrowed money earns a greater return represented by Cash Inflow each month than the principle and interest payments being Cash Outflowed.
Overview
Understanding Interest Expense: The Cost of Borrowing
When you borrow money for your business, it comes at a cost. This cost is called interest expense.
What is Interest Expense?
Interest expense is essentially the price you pay for using someone else’s money. Think of it like a rental fee for borrowing money.
Example:
If you take out a loan to buy a new piece of equipment, you’ll need to repay the original amount borrowed (the principal) plus interest. The interest is calculated based on the interest rate and the amount of money borrowed.
Where is Interest Expense Reported on the Income Statement?
Interest expense is categorized as a non-operating expense on your income statement. This means it’s separate from your operating expenses, such as salaries and rent.
Why is Interest Expense important?
- Accurate Financial Reporting: Correctly categorizing interest expense gives you a more accurate picture of your company’s profitability.
- Better Decision-Making: Understanding your true operating performance helps you make informed business decisions.
Cash Flow Matters
While accurately accounting for interest expense is important, don’t forget about the impact of your loan payments on your cash flow. Make sure you have enough cash on hand to cover both the principal and interest payments each month.
Key Takeaway:
Interest expense is a crucial aspect of business finance. By understanding how it works and managing it effectively, you can ensure the financial health of your company.