Okay, here goes. Warning: Everything I am about to say is grossly over-simplified. This is not sufficient information if you are actually doing accounting or writing accounting software. It's just an overview for budding CEOs. Pretend every sentence has (gross oversimplification) added to the end of it.

No, a liability is never an expense. A liability is a debt, something you owe. An expense is the cost of something you will consume within one year (salaries, taxes, office supplies, rent, interest, etc.).

A business reports three types of financials:

1. Profit and Loss. Always for some PERIOD, typically a week, a month, a quarter or a year. Very simply, revenues (sales) minus expenses equals profit.

2. Balance sheet. Always for some INSTANT, typically the end of the period above. Very simply, Assets (what you own) minus Liabilities (what you owe) equals book value, or shareholders' equity, what the business is in theory worth. (It's actually worth whatever someone would pay for it, or for a public company, the price of one share times the number of shares outstanding).

3. Statement of cash flows. Again, for a PERIOD. Cash at the start plus cash in minus cash out equals cash at the end. Cash out is not the same as an expense. For example, if you borrow money, it generates cash in but has no direct effect on profit and loss. When you pay back the loan, the principal payments are NOT an expense (the interest is).

An expense always affects profitability. If you have to buy $100 worth of office supplies, then you are $100 less profitable than you would otherwise have been. If you pay back $100 worth of debt, you are no less profitable than you would have been if you had left that $100 in the bank.

The three all have to balance to each other. For example, the book value at the end of last month plus this month's profit must equal the end of this month's book value. Your cash on hand is an asset -- the asset value has to jibe with the statement of cash flows.

Some examples:

You buy $100 worth of office supplies. That's an expense. If you pay cash, it is a hit to your cash position. If you buy on credit, then the debt is a liability.

You borrow $1000. That generates $1000 in cash and a liability. When you pay back the loan, you reverse those things. The interest (only) is an expense.

What about purchases that have a life of more than one year? You buy a desk for $1000. That generates a hit on cash (if you pay cash) or a liability (if you buy on credit) but not an expense. The desk becomes an asset. There is no expense from this transaction, and no immediate effect on the bottom line of the balance sheet: you gain a $1000 asset and balance that with either $1000 less cash or a $1000 liability. How does a long-lived asset "cost" the business's profitability? You divide the $1000 by the useful life of the desk -- let's say 5 years. Every year, you charge 1/5 of the cost -- $200 -- as an expense called "depreciation." Depreciation is always a non-cash expense. It's an expense, but there is no negative cash flow.

Got it?

Gerry said:

When you pay back the loan, the principal payments are NOT an expense (the interest is).

Ah, that really cleared it up for me, that was the part where I was getting confused. I was treating an interest payment on a loan and a loan repayment, as the same thing.

An expense always affects profitability. If you have to buy $100 worth of office supplies, then you are $100 less profitable than you would otherwise have been. If you pay back $100 worth of debt, you are no less profitable than you would have been if you had left that $100 in the bank.

That (along with the one year restriction) will help me remember the difference.

The other stuff was really interesting, especially the part about "depreciation" which I had yet to learn about. You have also given me a very good summary of my accounting fundamentals module that I can read over in the future to jog my memory.

Thank you for all your help. In the not too distant future (hopefully) people will be able to do a search on Google for the term "difference between a liability and an expense" and find your description.

Thank you, again.