Interest Expense

Interest Expense Definition

Interest expense is the cost a business pays for borrowing money. It includes interest on loans, lines of credit, credit cards, and any other debt. Interest expense appears on the income statement as a non-operating expense, separate from your core business costs. It reduces your net income and, in most cases, is tax-deductible.

Interest Expense in Practice — Example

A small retail shop has a $100,000 SBA loan at 7% annual interest and a $15,000 balance on a business credit card at 22% APR. This month, the loan accrues $583 in interest and the credit card adds $275. Total interest expense for the month is $858. The principal payments reduce the loan balance (a Balance Sheet transaction), but the $858 in interest hits the income statement as an expense.

Why Interest Expense Matters for Your Books

Interest expense directly reduces profitability. A business generating $200,000 in operating income but paying $30,000 in annual interest expense only keeps $170,000 before taxes. High interest costs can turn an otherwise healthy business into one that struggles to generate net profit.

Tracking interest expense separately from principal payments is essential for accurate financial reporting. Principal payments reduce your debt on the Balance Sheet but don't appear on the income statement. Interest is the cost of the debt and belongs on the P&L. Mixing them up distorts both your Balance Sheet and your income statement.

Interest expense also factors into financial ratios that lenders use to evaluate your business. The interest coverage ratio (operating income ÷ interest expense) tells lenders whether you can comfortably service your debt. A ratio below 1.5 is a red flag.

How Interest Expense Shows Up in QuickBooks

In QBO, interest expense shows up under Other Expenses on the Profit & Loss (below Operating Income). Create an account called "Interest Expense" in your Chart of Accounts if one doesn't exist. When recording loan payments, split the transaction: the interest portion goes to Interest Expense, and the principal portion goes to the loan liability account on the Balance Sheet. For credit card interest, categorize interest charges on the statement to the Interest Expense account during reconciliation.

Common Mistakes

Recording the entire loan payment as an expense: Only the interest portion is an expense. The principal portion is a Balance Sheet transaction that reduces your loan balance. Expensing the full payment overstates expenses and understates liabilities.

Not separating interest by loan: If you have multiple loans, track interest expense by loan (using sub-accounts or classes) so you can see which debt is costing you the most.

Forgetting to accrue interest at month-end: If your loan payment is due mid-month, you may need to accrue interest for the days between your last payment and month-end for accurate accrual-basis reporting.

FAQ

Q: Is interest expense tax-deductible?

A: Generally yes, for business loans and credit used for business purposes. There are limits for very large businesses under the Tax Cuts and Jobs Act, but most small businesses can deduct 100% of business interest expense.

Q: Where does interest expense appear on financial statements?

A: On the income statement under Other Expenses (below Operating Income, above Net Income). It's a non-operating expense because borrowing isn't your core business activity.

Related Terms

Liability

Note Payable

Operating Expense

Net Income

Long-Term Liability

> Need help making sense of your books? Ketchup cleans up your QuickBooks in 3–7 business days. Get your price →