A firm’s financing costs include
Select one:
a. costs of goods sold
b. interest expense
c. both A and B
d. depreciation expense
The correct answer and explanation is :
The correct answer is:
b. interest expense
Explanation:
A firm’s financing costs refer to the expenses incurred to obtain and use funds for business operations. These costs are primarily associated with debt financing, which includes interest payments on borrowed money. Interest expense represents the cost of borrowing funds from lenders, such as banks or bondholders. It is a crucial component of a firm’s financial structure, impacting profitability and cash flow.
Why Interest Expense is a Financing Cost?
Interest expense arises when a firm takes on debt through loans, bonds, or credit lines. The firm must pay periodic interest to the lenders as compensation for using their funds. This expense is reported on the income statement and reduces the firm’s net income.
Why the Other Options are Incorrect:
- Costs of Goods Sold (COGS)
- COGS refers to the direct costs of producing goods or services, including raw materials, labor, and manufacturing expenses.
- It is classified as an operating expense, not a financing cost.
- COGS affects gross profit, but it does not relate to the firm’s method of financing its operations.
- Depreciation Expense
- Depreciation represents the allocation of the cost of tangible assets (e.g., machinery, buildings) over their useful life.
- It is a non-cash accounting expense, meaning it does not involve actual cash outflow.
- Depreciation is considered an operating expense rather than a financing cost.
Conclusion:
Financing costs strictly pertain to expenses related to acquiring capital, and interest expense is the primary financing cost. COGS and depreciation are related to operational and accounting aspects rather than financing. Thus, the correct answer is B: interest expense.