What is financial cost? Forms and ways to manage costs effectively

When running a business, understanding what financial costs are and how to manage them effectively is key to maintaining stability and sustainable growth. Financial costs include expenses related to the financial activities of the business, such as interest, bond issuance costs, and banking service fees. 

Understanding and managing these costs well helps businesses optimize resources and increase competitiveness. Bizzi will help you discover the forms and methods of managing financial costs effectively.

What are financial costs?

Financial Charges are the sum of payments for the use of capital over a given period of time. Simply put, financial charges are expenses or losses arising from a business's financial investment activities. 

These expenses include: interest on loans, interest on deferred purchases, financial asset leasing costs, foreign currency sales losses, payment discounts to buyers, losses from liquidation or sale of investments, exchange rate losses, and provisions for declines in the value of trading securities or losses on investments in other entities.

The role of financial costs:

Financial costs play an important role in determining business performance and directly affect the company's profits. Effective management of financial costs helps businesses better control expenses, avoid loss and corruption, and optimize the use of capital.

The meaning of financial costs for businesses:

• Reflecting business performance: Financial costs are an important indicator to evaluate the business performance of an enterprise. Managing and analyzing financial costs helps enterprises make decisions on effective capital use, optimize costs and enhance competitiveness in the market.
• Control and prevent asset loss: Effective financial cost management helps businesses closely control expenditures, thereby preventing embezzlement, loss and corruption. This ensures that financial resources are used for the right purposes and effectively.
• Strategic decision support and risk management: Financial costs are an important factor in determining product prices, building business strategies and managing risks. Understanding and managing financial costs well helps businesses make accurate strategic decisions, optimize costs and increase competitiveness in the market.
• Ensuring financial stability: Effective financial cost management contributes to ensuring the financial stability of the enterprise. Good cost control helps enterprises maintain solvency, minimize financial risks and create a solid foundation for sustainable development.

Types of financial costs that businesses need to know

Debtor finance costs 

These are expenses incurred by businesses when they borrow money or use foreign capital. These expenses include:

• Interest expense on loans, deferred purchase interest, and finance lease interest: Interest payable when a business borrows capital, purchases goods on credit or leases assets under a financial lease.
• Loss from foreign exchange sales: Occurs when a business sells foreign currency at a lower exchange rate than the buying rate, resulting in a loss.
• Payment discount for buyers: A discount that a business offers to customers when they pay early or on time.
• Costs of liquidating or selling investments: Arising when a business sells or liquidates investments at a price lower than book value, resulting in a loss.
• Expenses arising from exchange rate losses during the period: Occurs when there is an exchange rate difference between the time of recording and the time of payment of foreign currency-denominated monetary items.
• Exchange rate loss due to revaluation of year-end monetary items: Arising when an enterprise revalues foreign currency monetary items at the end of the accounting period and realizes a loss due to exchange rate differences.
• Expenses from provisioning for devaluation of trading securities and provision for investment losses: Provisions are made when the market value of a trading security or investment falls below its book value.
• Other expenses from financial investment activities: Includes costs related to financial investment activities that are not specifically listed.

Credit side financial costs: 

In accounting, Account 635 – Financial expenses is used to reflect expenses related to the financial activities of the enterprise. The credits of this account include:

• Reversal of provision for devaluation of trading securities and provision for loss on investments in other entities: When the market value of trading securities or investments in other entities increases again after making provisions for devaluation or loss, the enterprise will reverse this provision. The reversal is recorded on the credit side of Account 635, reflecting the reduction in financial expenses.
• Financial expenses are recorded as reductions: In case the enterprise issues bonds with premium, this premium is gradually allocated to financial expenses in accounting periods. When allocated, the corresponding financial expense will be recorded as a decrease in the credit side of Account 635. 
• Transfer of financial expenses at the end of the period: At the end of the accounting period, all financial expenses incurred during the period will be transferred to determine the business results. Specifically, the debit balance of Account 635 will be transferred to Account 911 - Determining business results.

Items not included in financial expenses:

• Selling costs: Includes expenses related to marketing, advertising, shipping and distributing products to customers. These costs are accounted for separately and are not part of financial costs.
• Business management costs: These are costs associated with the management and administration of a business, such as management salaries, office expenses, consulting services, and other administrative expenses. These costs are not included in financial expenses.
• Production and business costs: Includes raw material costs, direct labor, manufacturing overhead, and costs directly related to the production of products or provision of services. These costs are not included in financial costs.
• Basic construction costs: Are expenses related to construction, purchase of fixed assets or other long-term investment projects. These costs are accounted for separately and are not part of financial expenses.
• Real estate business costs: Includes costs associated with the purchase, lease or management of real estate. These costs are not included in finance costs.
• Costs covered by other funding sources: These are expenses that are offset by other sources of funding, such as welfare funds, reward funds or sponsorships. These expenses are not included in financial expenses.

What are the common forms of financial costs?

Interest rate

Interest expense is the amount of money that a business or individual must pay to the lender when using borrowed capital. This is one of the common financial expenses and has a great impact on business performance. Below are some common types of interest expenses that businesses encounter:

• Annual interest rate on purchases: Is the interest cost applied to installment purchases or credit card purchases.
• Cash advance interest rate: Applies when customers withdraw cash from a credit card, usually with a higher interest rate than the purchase interest rate.
• Penalty interest: Applied when customers do not pay on time or exceed the credit limit.
• Referral Rate: Preferential interest rates apply initially when opening a credit card or taking out a loan, then will switch to normal interest rates.
• Balance transfer interest rate: Applicable when customers transfer outstanding balance from one credit card to another credit card with preferential interest rate.

Initiation fee

Origination Fee is the fee that the borrower must pay to the bank or financial institution to process and complete the loan application. This fee usually ranges from 0.5% to 1% loan value, commonly applied to mortgage loans, personal loans, student loans and auto loans. 

This fee helps the lender cover the costs of appraisal, underwriting, and financing. However, the specific fee may vary depending on the bank and the type of loan.

Late Fee

Late fees are fees that borrowers must pay when they fail to pay their debts on time as agreed in the credit contract. This fee is usually clearly stated in the loan contract or according to the policy of the bank or credit institution. 

Late fee regulations may vary depending on the lender and loan type (credit loan, mortgage, consumer loan, etc.), and must comply with applicable laws.

Prepayment penalty

A fee that a borrower must pay when paying off a loan before the agreed term. The purpose of this fee is to compensate the lender for the loss of interest that the borrower incurs due to the borrower paying off the loan early.

Financial cost accounting

In the accounting system, account 635 (Expenses and other profits and losses) is used to record financial expenses. This account helps to summarize expenses related to interest, losses and other expenses, accurately reflecting the financial situation of the enterprise.

Debit: Expenses that need to be recorded on the Debit side include:

• Interest expense: This is the cost arising from borrowing capital to serve production and business activities.
• Interest on purchases on credit and rental income: These interests arise when a business purchases goods or leases assets but does not pay immediately.
• Loss from foreign exchange sales: When a business conducts foreign currency transactions and incurs losses.
• Loss from payment discounts to buyers: Loss arising from discounts to encourage customers to pay early.
• Loss from liquidation or sale of investments: These losses arise when a business sells investment assets for less than their book value.
• Loss due to exchange rate changes: Exchange rate fluctuations may affect the value of assets and receivables denominated in foreign currencies.
• Provision for devaluation of trading securities: To protect the business from risks related to the value of securities.
• Costs related to other financial investment activities: Includes other expenses incurred during the investment process.

Credit side: For the Credit side, the amounts to be recorded include:

• Reversal of provision for diminution in value of securities: When the stock value recovers, the enterprise needs to re-record the provision that has been made.
• Financial expense transferAt the end of the period, all financial expenses incurred during the period will be transferred to account 911 to determine business performance.

Accounting for common financial costs:

Accurately recording and classifying these expenses helps businesses evaluate their performance and make strategic decisions. Here is a detailed guide on how to account for common types of financial expenses.

On losses from financial investments:

• When recording losses from selling securities:
  • Debit account 111, 112: Reflects the actual value of assets received from selling securities or investments.
  • Debit account 635 – Financial expenses (loss): Reflects the loss arising from the sale of trading securities or investments.
  • There are accounts 121, 221, 222, 228: Recording the book value of securities traded or invested in subsidiaries, joint ventures, and associates sold.

About payment discount:

• When a business makes a discount:
  • Debit account 635 – Financial expenses: Reflects expenses arising from discounting.
  • There are accounts 131, 111, 112: Reflecting the value deducted from receivables or cash.

Regarding accounting for interest expenses and bond interest:

• When accounting for interest expenses on loans or bond interest periodically:
  • Debit account 635 – Financial expenses: Reflects interest expenses.
  • There are accounts 111, 112: Reflecting cash or bank accounts.
• When a business prepays loan interest or bond interest to the lender:
  • Debit account 242 – Prepaid expenses: Record prepaid interest expenses.
  • There are accounts 111, 112: Reflecting cash deductions.
• When allocating loan interest or bond interest according to the periodic payment amount to financial expenses:
  • Debit account 635 – Financial expenses: Record interest expenses.
  • Credit account 242 – Prepaid expenses: Reflects the allocation of prepaid interest expenses into current expenses.

About loan with interest payment later:

• When calculating loan interest or bond interest during the period:
  • Debit account 635 – Financial expenses: Reflects interest expenses incurred.
  • Credit account 341, 335: Record loans and financial lease debts.
• When the loan expires and the business repays the principal and interest on the loan:
  • Debit accounts 341, 34311, 335, 635: Reflects all payables.

Financial cost analysis

When financial costs increase

Reason

• Interest rate increase: As market interest rates rise, so do businesses' borrowing costs, increasing financial pressure.
• Expanding the scope of loans: Businesses expand their operations, invest in production, expand markets or purchase assets, leading to higher demand for loans.
• Increase the number of financial contracts: Entering into multiple financial contracts, such as issuing bonds, borrowing from banks or taking out credit facilities, increases financial costs.

Reflection

• Boost your business: Increased financial costs can be a sign that a business is investing heavily in development, expanding production scale and looking for growth opportunities.
• Increased financial burden: If financial costs increase without accompanying growth in revenue and profits, businesses may have difficulty balancing their finances and face higher debt repayment pressure.
• Risk of loss: Excessive financial costs can reduce net profits, especially if the business has not optimized its capital sources and the efficiency of using borrowed capital.

When finance costs decrease

Reason

• Interest rate reduction: When market interest rates fall, businesses' interest costs also fall, helping to save a significant amount.
• Reduced loan demand: Businesses may have completed major investment projects, optimizing cash flow and reducing dependence on borrowed capital.
• Reduce the number of financial contracts: Paying off old debts and limiting participation in new financial contracts also helps businesses better control financial costs.

Reflection

• Effective cost control: Cutting financial costs can show that a business is managing capital well, optimizing spending and improving business performance.
• Challenges in business operations: On the contrary, if financial costs decrease due to businesses narrowing operations or limiting borrowing due to financial difficulties, this could be a warning sign of unfavorable business conditions.

Effective financial cost management

Establish strict management policies and procedures

Developing and implementing clear financial policies helps businesses control cash flow effectively, limit losses and ensure that expenses are specifically planned. Some important principles include:

• Build a transparent financial cost approval process with strict control from related departments.
• Monitor and periodically evaluate expenses to promptly adjust and optimize cash flow.
• Apply technology and accounting software to automate the tracking process, helping to minimize errors and improve management efficiency.

Long-term planning for borrowing and debt management

A sustainable financial strategy requires a business to have a long-term plan for borrowing and using financial resources. This helps reduce payment pressure and avoid risks arising from interest rate fluctuations or cash flow shortages.

• Carefully assess your ability to pay before borrowing, ensuring that your business has sufficient resources to meet its financial obligations.
• Choose loan forms that suit your business goals and optimize interest costs.
• Develop a clear debt repayment plan and have a backup plan to ensure no business interruption.

Mobile Banking Application to Optimize Financial Management

Digital technology is increasingly developing, providing businesses with many tools to support more effective financial management. Mobile Banking is one of the useful solutions, helping businesses control financial costs anytime, anywhere.

• Track transactions, check account balances and manage cash flow quickly and accurately.
• Automate recurring payments, avoid late payments and save time for the accounting department.
• Connect with accounting software, helping businesses have an overview of the financial situation and make timely decisions.

Distinguish between financial costs and financial revenues

Below is a table distinguishing the difference between Financial Expenses and Financial Revenues that businesses are often interested in:

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