“I still don’t get it,” said Ahmir, “how can all the monthly loan repayments we make to the bank for the dining room expansion project we completed last year not be considered an operating expense? We make the payments out of the money we get from being able to serve more customers. That’s income. Our loan payments should be an expense!” 

Ahmir was a new assistant manager at the Causeway Bay restaurant, and he was talking to Becky, the restaurant’s manager. Becky was preparing the operation’s SCF and had just been explaining to Ahmir that debt payments, like the ones made to pay off the loan the restaurant had taken to expand the dining room last year, were not classified as operating expenses for the purposes of preparing an SCF. 

“Well Ahmir,” replied Becky, “think of it this way. Debt repayment is not really an operating expense, it’s actually just an internal cash transfer. The only part that’s an expense is the interest. The expense part actually happened last year when we incurred the debt.” Seeing the still puzzled look on Ahmir’s face, 

Becky continued, “Ahmir, let me ask you, do you have a credit card?” 

“Yes,” replied Ahmir “I do.”

“O.K.,” said Becky, “assume you owe $1000 on your credit card and you have $400 in your checking account and no other savings. Your net worth is −$600. If you write a $100 check and send it to your credit card company, now you’ve got $900 in debt and $300 in your checking account. Right?”

“I get it now,” said Ahmir, “my net worth would still be −$600.”

“Right,” said Becky, “your expense actually came when you put the $1000 on your credit card, not as you pay it off.”

1. Why is it important that managers know the amount of interest paid on money that has been borrowed for the purpose of expanding or operating their businesses?

2. Whether it is understood as an expense or not, debt repayments must be made. What would be the likely result if a business consistently lacked the funds in its checking account to make the transfers required for debt repayment?