Is interest expense an operating expense?

Is Interest Expense an Operating or Non-Operating Expense? The Accounting Answer

Interest expense is generally a non-operating expense under both GAAP and IFRS. It is typically presented below operating income (EBIT) and above earnings before tax (EBT), and it is not included in operating profit.

That’s because interest is treated as a financing cost, not a cost of core business operations.

What Is Interest Expense?

Interest expense is the cost of borrowing money.

At a basic level:

Principal × Interest Rate × Time = Interest Cost
(though actual loan calculations may be more complex)

Common sources of interest expense include:

• Bank loans
• Lines of credit
• Bonds
• Business mortgages
• Equipment financing
• Lease liabilities (including financing-type lease interest)

It is important to distinguish interest expense from:

• Principal repayment: reduces a liability on the balance sheet, not an expense
• Dividend payments: distributions to owners, not expenses
• Interest income: income earned, not borrowing cost
  

Why Interest Expense Is Not an Operating Expense

Operating expenses are costs of running the core business—things like payroll, rent, and marketing.

Interest expense is different. It reflects how the business is financed, not how it operates.

A common way to think about it:

Two otherwise identical companies—one funded entirely with equity and one funded with debt—should generally report the same operating income, even though one has interest expense and the other does not.

That is why interest is classified outside operating expenses.

Where Interest Expense Appears on the Income Statement

A simplified income statement often looks like this:

Revenue
− COGS
= Gross Profit

Gross Profit
− Operating Expenses
= EBIT (Operating Income)

EBIT
− Interest Expense
= EBT

EBT
− Income Tax
= Net Income

Illustrative example:

• Revenue: $500,000
• COGS: $200,000
• Gross Profit: $300,000
• Operating Expenses: $180,000
• EBIT: $120,000
• Interest Expense: $20,000
• EBT: $100,000
• Taxes: $25,000
• Net Income: $75,000

Interest is “below the line,” meaning below EBIT.

Why This Classification Matters: EBIT, EBITDA, and Valuation

This classification affects important financial metrics.

Lenders and acquirers often use EBIT and EBITDA to evaluate operating performance independent of financing choices.

Examples:

• Debt-to-EBITDA ratios
• Interest coverage ratios
• Loan covenant calculations

A covenant might require:
Debt-to-EBITDA below 3.0x

If interest is incorrectly classified as an operating expense, those metrics can be distorted.

That can affect:

• Valuation
• Debt compliance
• Performance analysis
  

Is Business Interest Expense Tax Deductible?

Generally yes.

Under IRC Section 163, interest on debt used to generate business income is generally deductible, subject to limitations. (irs.gov)

Examples may include interest on:

• Business loans
• Working capital lines
• Equipment financing
• Business mortgages

If personal borrowing is used partly for business purposes, allocation may be required.

Good documentation includes:

• Loan agreements
• Interest statements
• Amortization schedules
  

Section 163(j): The Business Interest Deduction Limit

A major exception is Section 163(j).

Businesses above the gross receipts threshold (generally around $30 million, inflation adjusted) may face a limit on deducting business interest, often based on:

• 30% of adjusted taxable income (ATI), plus
• Business interest income

Disallowed interest may generally carry forward indefinitely.

Many smaller businesses under the threshold may qualify for exemption, but businesses approaching the limit often benefit from modeling the impact before adding debt.

Interest Expense for Financial Companies: The Exception

There is an important exception.

For banks and other financial institutions, interest paid to depositors or funding providers can be part of core operations and may be treated as an operating expense.

That is industry-specific.

For most non-financial businesses, interest remains a non-operating expense.

How to Record Interest Expense in Your Books

Monthly accrual

Record accrued interest:

Debit: Interest Expense
Credit: Interest Payable

When payment is made

Pay accrued interest:

Debit: Interest Payable
Credit: Cash

For amortizing loans, each payment usually includes:

• Interest expense portion
• Principal reduction portion

Use an amortization schedule to split those correctly.

A best practice is maintaining a dedicated Interest Expense account in the chart of accounts, positioned below operating expenses for proper financial statement presentation.

How Slash Helps Businesses Track and Control Debt-Related Costs

Slash is a business banking platform that can captures interest charges from business loan accounts and credit cards and automatically categorize them as financing costs separate from operating expenses. Our solution can provide visibility into total debt service as a distinct budget line. Slash also offers cash flow forecasting tools with the help of our built-in AI agent, Twin.