What is Non-Operating Expenses?
The term “non-operating expenses” refers to the various business expenses that are not related to the company’s core operations. Conversely, non-operating expenses are those expenses that are not included in the calculation of EBIT (earnings before interest and tax), which is also known as the operating profit of a company. Some of the most commonly used non-operating expenses are interest expense and losses incurred on disposal or sales of assets.
Explanation
As the name suggests, non-operating expenses is an umbrella term for expenses that don’t take place due to a company’s routine activities. Such expenses provide outside support to the company’s financial but not to the company’s core business operation. For instance, a company typically categorizes cost incurred due to borrowing, expense owing to currency translation or losses incurred during the sell off of assets as non-operating expenses.
Typically, analysts prefer to adjust the earnings for non-operating expenses as well as non-operating income in order to evaluate the performance of the core operation of a company. In this way, the analysts are able to remove the effects of financing and other irrelevant expenses from a company’s financial analysis.
Examples of Non-Operating Expenses
Following are the examples are given below:
Example #1
All businesses require fund for fuelling growth and so companies resort to a mix of equity and debt to finance their business growth. Consequently, the companies have to bear the interest expense and pay at regular interval irrespective of the mix of the debt in the overall capital structure. Determine whether the interest expense is a non-operating expense or not
Now, we need to understand that although debt financing facilitates business growth but it is not part of the core operations of any company. As such, the interest payment is considered a non-operating expense.
Example #2
Let us take the example of a company that is engaged in the business of building construction. In the last couple of years the company has been able to generate significant profit resulting in the accumulation of a huge cash balance. Consequently, it has been investing the unused cash in equities of other listed companies. Determine the nature of the expenses incurred for hiring personnel for carrying out the investment activities.
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Now, the company is into building construction and not an investment company. So, the investment activities don’t qualify as core operations of the company and as such the expenses incurred in the process is considered to be non-operating expenses.
Example #3
Let us take the example of a mutual fund investment company. Determine the nature of the expenses incurred for hiring personnel for carrying out the investment activities.
Now, the company is into investing in mutual funds and so the investment activities qualify as the core operations of the company. As such, in this case, the expenses incurred for carrying out the investment activities is not considered a non-operating expense.
Example #4
Let us take the example of the investment company again. This time the company has entered into a partnership with another building construction firm as the sleeping partner. During one of the years, the partnership firm incurred operating losses. Determine the nature of the losses in the books of the investment company.
Now, the company is into mutual fund investment and not into building construction. So, the investment in the partnership firm doesn’t qualify as core operations of the company. As such, the losses incurred by the partnership firm will be recognized as non-operating expenses in the books of the investment company.
What is Included in Non-Operating Expenses?
Basically non-operating expenses are the expenses that don’t arise out of the principal activities of the business and so they are usually captured below the operating results from continuing operations on a company’s income statement. Some of the most common (not exhaustive) examples of non-operating expenses include:
- Financial expenses, such as interest expense or derivative expense
- Expense towards lawsuit settlement
- The loss incurred on the disposal of assets
- Charges for obsolete inventory
- Expenses due to the restructuring of an existing firm
- Expenses incurred due to relocation of business
- Expenses caused due to weather damage
- Expenses incurred in acquiring another firm
Importance of Non-Operating Expenses
It is true that non-operating expenses are captured at the bottom of the income statement, but it doesn’t undermine the importance of these expenses. The structure of the income statement is built in such a way that the users of the financial statements can easily assess the performance of the business on the basis of the activities captured at the top of the income statement. But it is also important for analysts and investors to understand the trend in the operating expenses as it can potentially affect the financial performance of a company. For instance, the cash balance of a company can deteriorate if it continues to incur non-operating recurring losses over a long period of time. So, analysts and investors should also pay heed to these expenses after analyzing the core business risks.
Advantages
Some of the major advantages are as follows:
- Disclosure of non-operating expenses results in transparency that is appreciated by all stakeholders – investors and even employees.
- Companies can cut down on non-operating expenses relatively easily as compared to core business expenses.
- Recognizing non-operating expenses and operating expenses separately in the income statement help analysts to assess the performance of the core business far more easily.
Disadvantages
Some of the major disadvantages are as follows:
- There is often the risk of manipulation by accountants wherein they can classify an operating expense as a non-operating expense in order to boost the earning from the core business.
- Lack of any standard criteria for bifurcating operating expenses and non-operating expenses results in confusion.
Conclusion
So, it can be seen that although non-operating expenses are captured separately in the income statement, these expenses are still important for managers, investors, and other stakeholders in the assessment of the future financial viability of a company.
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