Explanation Of Finance expense

Definition of Finance expense

Finance expense also known as finance cost or cost of finance is the interest and other charges incurred to borrow or purchase an asset. It is the total expense directly associated with an asset being used in a business.

Brief Explanation Of Finance expense

The expenses include Interests on debentures, bonds, loans, Income taxes, consultancy fee of financial institution etc.

Every company needs capital to run its business. The two ways to raise capital are Equity and Debt.

Equity means lending of money from shareholders in the form of shares. In this type of capital raising no interest or tax is paid to the shareholder apart from dividend.

However, in debt raising there are bonds, debentures, certificates, mortgages and loans etc. In all these kind of debt the borrower has to pay a fixed amount of interest to its lenders. Also to raise debt consultancy fee of financial institution, salary of the dedicated employee etc. has to be paid. All this cost of bringing and maintaining this money in the business is called finance cost.

Interest or Finance cost is an element of Statement of Financial Income and one of the main advantage of finance cost is that its tax deductible

Interest rates are of two types

  • Variable Interest Rate
  • Fixed interest rate

Variable Interest Rate:

The reflection of fluctuation of market index rate in an interest is called variable interest rate

  • If interest rates increase over the time a company may find it difficult to pay its obligations.
  • It is good for short term purpose since near future can be predicted more accurately.

Fixed Interest Rate:

This means that the rate of interest charged to a company would not change no matter what the market situation is.

  • The company would always the exact amount of cash outflow in the form of interest.
  • If market interest rates go high, it does not affect the company’s interest outflow
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