What Are Operating Expenses? Basics and Examples
For a non-manufacturing company, operating expenses might be defined as including all expenses necessary for running the business. Manufacturing companies, however, break expenses down, with the cost of goods sold (COGS) separated from other expenses so a simple gross margin can be calculated as revenue minus COGS. Then, most other expenses are classified as operating expenses. We’ll use this approach in this article.
Operating expenses are the overhead costs a business incurs to maintain its day-to-day operations. Examples include the non-manufacturing component of payroll, rent, office supplies, and utility costs. These operating expenses—also known as OPEX or Selling, General, and Administrative (SG&A) expenses—should be regarded as separate from costs incurred due to capital investments in assets (CAPEX) and activities directly involved in the production of goods and services (COGS).
Because operating expenses play a large role in the profitability of a business, business owners should understand the details of their own operating costs and how they impact the bottom line. This guide will help. Read on to learn about the different operating expenses and how to calculate these expenses for your company.
- What are operating expenses?
- What do operating expenses say about your business?
- Common examples of operating expenses for businesses
- Operating vs. non-operating expenses
- Operating expenses vs. capital expenses
- How to calculate operating expenses
- Clarifying potential operating expenses
What are operating expenses?
Generally, operating expenses are costs that a business incurs to maintain its core operations on a daily basis. Operating expenses include any overhead costs that support, but don’t directly relate to, the production of your service or product. These costs are outlined on the company’s income statement. The income statement is typically the go-to resource for reporting operating income and net income.
What do operating expenses say about your business?
The operating costs that a business incurs on a routine basis play a large role in the valuation of the company. Business owners must manage operating expenses in relation to profits wisely. While overhead is always on the chopping block when a company wants to cut costs, finding the right balance is key. If OPEX is cut too much, the effectiveness of your business could suffer.
By keeping up-to-date on the way business operations are impacting your bottom line, you can improve your strategy for maximizing the relevant profit margins and valuation of your company.
Common examples of operating expenses for businesses
Small business entrepreneurs, CPA professionals, and other corporate finance managers often deal with a common collection of operating expenses. Nearly all companies deal with sales costs, administrative expenses, utility costs, and other common operating costs. Below are the most typical examples of operating expenses that a business incurs. Note that this applies to the non-manufacturing components of these factors.
Sales and marketing
All sales and marketing activities paid for by a business are considered operating costs. Examples of sales and marketing costs that qualify as OPEX include website management, paid advertising, promotional materials, signage, sales and marketing staff salaries, travel and entertainment, and any other sales and marketing operations.
Leases and rents
When a business owner pays to rent a location or facility for office operations or other SG&A business activities, the costs associated with that rental are considered OPEX.
Items routinely used by SG&A office staff, such as paper, ink, pens, staples, cleaning supplies, and other office supplies, are always categorized as operating expenses.
Operating costs are associated with the repair or maintenance of any business asset. This includes office cleaning and maintenance services performed on office equipment or the buildings and landscaping.
Water, electricity, gas, internet, telephone, garbage collection, and any other utility costs are categorized as operating costs. Your monthly bills for each of these services will be listed on your income statement under the OPEX section.
Assets, such as computer equipment, office furniture, company vehicles, and other major assets undergo wear and tear over time; their lost value is considered an operating expense, reported as depreciation.
Employee wages, employee benefits, and payroll taxes are all considered operating costs, as are the administrative expenses associated with running payroll.
No matter which type of employee benefits program your small business offers, the costs associated with running the program can be categorized as OPEX. This includes costs incurred due to:
- Health insurance
- Dental or vision insurance
- Life insurance
- Disability insurance
- Retirement benefits
- Gym memberships
- Paid holidays
- Paid time off (PTO) and vacation
Any time your business makes payments for insurance, either to initiate a contract or to pay premiums, those costs are considered operating expenses. This includes your company’s general liability insurance, fire insurance, commercial property insurance, workers’ compensation insurance, and any other insurance policy.
Operating vs. non-operating expenses
Operating expenses are business costs associated with daily business operations that support the company’s core operations. In contrast, non-operating expenses are often one-time expenditures or related to the company’s financial activities such as interest expenses, legal settlements, layoffs, and other items not directly tied to operations.
Operating expenses vs. capital expenses
Operating expenses are ongoing costs reported on profit and loss financial statements. Capital investments are usually large, up-front purchases of capital assets. These capital expenditures (CAPEX) are reported on a cash flow statement. Only the allowed depreciation for these capital assets flows to the annual income statement.
Examples of capital expenses:
- Patents, trademarks, etc.
- Real estate purchases
- Building renovations
- Manufacturing equipment
- Company vehicles
- Computer and other IT equipment
Examples of operating expenses (for SG&A items):
- Sales and marketing costs
- Leases or rents
- Property taxes
- Office supplies
- Utility costs
- Payroll and payroll taxes
- Employee benefits
- Vehicle expenses
- Subscriptions and licenses
- Legal fees
Why separate capital and operating expenses?
Capital expenditures are generally large, one-time expenses separate from the day-to-day operating expenses of running the business. These costs are kept separate from operating expenses in accounting to provide a more useful representation of how effectively a business is operating.
Furthermore, the separation of operating expenses and capital expenses in accounting allows a business to track depreciation costs beyond the initial purchase cost of an asset. The IRS requires that companies follow specific rules for capitalizing expenses as depreciation, another reason why capital expenditures must be separated from operating expenses.
Your CPA or other finance manager will document the one-time purchase cost of an asset in your capital expense report and will continue to calculate depreciation costs for that asset in your ongoing operating expense reports.
How to calculate operating expenses
Entrepreneurs, business managers, CPAs, and other financial professionals should hold a solid understanding of operating expenses and how to calculate them.
Correctly calculating your company’s operating expenses is important for calculating the overall profits of your business and clearly understanding your financial performance.
Standard operating expenses (OPEX) formula
The basic formula most businesses can use to calculate standard operating expenses is to simply add up all of your non-manufacturing operating expenses. The sum is your basic operating expenditure (OPEX).
This simple calculation is useful for various financial reporting activities, including calculating your operating expense ratio (OER), a useful statistic in gauging the financial health of an organization.
Overall operating costs formula
You may want a broader picture of your company’s operating costs that incorporates overhead expenses (OPEX/SG&A), research and development (R&D), and the cost of goods sold (COGS). To include all these items in your operating costs calculations, follow this formula:
This calculation provides an overall perspective of how your business is spending money.
What is the operating expense ratio (OER)?
The operating expense ratio (OER) can be used by any business to achieve a practical measurement of the ratio of expenses to revenue, giving an indication of the health of the business. OER is stated as a percentage. A low OER may be associated with a high net income ratio, meaning more profits. A high OER might indicate a low net income and low profits.
You can calculate the OER for your business using this simple equation:
By comparing your company’s annual OER with past OER calculations, as well as the OER data for other companies in your industry, you can note if the ratio increases and take action accordingly, such as auditing your maintenance expenses and utility bills and checking the specific costs paid, so you can identify any unexpected increases in your OPEX.
Clarifying potential operating expenses
If you’re organizing the financial statements for your small business and wondering whether specific items are operating expenses, check the list below.
It depends. The depreciation of a fixed asset is categorized as an operating expense (OPEX) for SG&A equipment, such as sales team office furniture and other assets not involved in the core product or service. However, depreciation of tangible assets directly involved in producing products or services (machinery, equipment, and other professional tools of the core trade) is categorized as COGS, not operating expenses.
Yes, amortization costs for intangible assets, such as patents, copyrights, and franchise agreements, do fall under the category of operating expenditures. Costs associated with intangible assets are regarded similarly to tangible assets that go through depreciation.
No. As the cost of borrowing money, interest is not categorized as an operating expense. Rather than appearing under an “Operating” category on your income statement, the interest expenses paid by your company during the reporting period will show as a line item under the “Non-Operating” category.
No, income tax expenses are not operating expenses and should be kept separate from operating expenses that clearly support the company’s core operations. In fact, income tax is calculated after COGS, operating expenses, and other items have been subtracted from revenue or gross income.
Research and development
Yes, all research and development (R&D) expenditures are categorized as operating expenses. These are wage and supply expenses for those individuals developing new products or services and are always placed in the operating section of an income statement. R&D may sometimes appear as a separate line item in the expense section.
Yes, your commercial insurance policies are operating expenses. This includes any fees associated with initiating the contract and monthly premiums.
No. When a business collects sales tax from customers, that tax money is due to the government as a liability and is never considered an expense of any kind.
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This article is intended for educational purposes and should not be viewed as legal or tax advice. Please consult a professional to find the solution that best fits your situation.