What Are Operating Expenses and How to Calculate It
Understanding what operating expenses are and how to calculate them is important for business owners.
Do you know what your company’s “operating expenses” are?
In this blog post, we’ll take a closer look at operating expenses and learn how to calculate them. Let’s get started!
What Are Operating Expenses?
Operating expenses (OPEX) are the costs associated with running a business. These include rent, utilities, labor, insurance, and other daily expenses.
Many businesses outsource certain operating expenses, such as accounting or customer service, to save on costs. Operating expenses can significantly impact a company’s bottom line, so businesses must carefully track and manage them.
Operating expenses can be divided into two categories: variable costs and fixed costs. Variable costs are those that fluctuate based on production levels or sales volume. Fixed costs remain constant regardless of production levels or sales volume. Examples of variable costs include raw materials, commissions, and shipping fees associated with dropshipping, overnight shipping, and expedited shipping. Examples of fixed costs include rent, salaries, and insurance.
What are Operating Activities?
Operating activities are the core activities that generate revenues and incur expenses for a company. Operating activities include selling goods, manufacturing, rendering services, etc. The cash flow from operating activities measures a company’s ability to generate cash from its day-to-day operations, which is included in the statement of cash flows.
The cash flow from operating activities can be either positive or negative. A positive cash flow indicates that a company generates more cash than spending, while a negative cash flow means the opposite.
What Is Included In Operating Expenses?
Operating expenses include all the costs associated with running a business daily. Below are examples of these expenses.
Operating Expenses Examples
Here is a closer look at 16 of the most common types of operating expenses:
- Travel expenses: airfare, lodging, car rental, and other travel-related costs incurred while conducting business.
- License fees: state and local licenses and permits required to operate your business. (e.g., a wholesale license, an eCommerce business license, and even a license for selling alcohol online)
- Research: costs associated with market research, product development, and similar activities.
- Accounting fees: Fees paid to an accountant or bookkeeper for services such as tax preparation, financial statement preparation, and bookkeeping.
- Attorney fees: These refer to the cost of legal services associated with your business, including filing incorporation papers or defending against a lawsuit.
- Vehicle expenses: the cost of maintaining and operating a vehicle used for business purposes, including gas, insurance, repairs, and depreciation.
- Office supplies: the cost of paper, ink, toner, and other office supplies used in the course of doing business. It may also include restaurant supplies and cleaning supplies in the restaurant industry.
- Depreciation: the gradual reduction in the value of an asset over time. For businesses, this includes office equipment, restaurant equipment, vehicles, and other property depreciation.
- Advertising and marketing: the cost of promoting your business through B2B marketing, DTC advertising, PR, and other marketing activities. Just be sure you know your customer profile to avoid any ineffective marketing strategies.
- Property tax: a tax levied on real estate by local governments.
- Inventory: the cost of goods sold purchased for resale or used in the production of services (raw materials, finished goods, etc.). For an eatery, this can also include the restaurant food cost.
- Rent: the cost of leasing space for your office or store (commercial rent).
- Payroll: the cost of salaries and wages paid to employees, as well as payroll taxes and benefits.
- Maintenance and repairs: the cost of routine upkeep and unexpected repairs for your office, store, or other business property.
- Utilities: the cost of water, electricity, gas, and other utilities used in the course of doing business.
- Insurance: the cost of insuring your business against liability, property damage, theft, and other risks.
Operating expenses vary from one business to the next. By carefully tracking and managing each cost, businesses can ensure they remain financially stable and sustainable over the long term. It's important to note that not all businesses will have every type of operating expense listed here, and there may be additional expenses specific to their industry or operations. Additionally, some expenses may be considered capital expenditures rather than operating expenses, depending on how they are classified for accounting purposes.
Importance of Operating Expenses
Operating expenses are important because they directly impact a company’s bottom line. Higher operating expenses mean lower profits. Therefore, companies need to keep a close eye on their operating expenses and work to reduce them whenever possible.
There are various methods to control and reduce operating expenses. One way is to increase efficiency within the company. This can be done by streamlining processes, automating tasks, and eliminating waste. For example, a company might implement just-in-time inventory management to reduce the need for storage space and save on warehousing costs.
Another way to reduce operating expenses is to negotiate better deals with wholesale dropshipping suppliers or vendors. This can be done by shopping around for better prices and terms and being willing to walk away from a deal if the terms are unfavorable.
Carefully managing operating expenses is critical for any business that wants to be successful in the long term. By keeping costs under control, businesses can boost their profits and reinvest them into further growing their businesses.
How to Get Operating Expenses
Operating expenses are one of the most important financial indicators for a business. They are included in the company’s income statement, including financial statements such as the statement of cash flows. You can use them to measure a company’s operational efficiency and compare it with other businesses in its industry. Operating expenses can also be used to assess a company’s financial health.
There are several ways to calculate operating expenses. The most common method is to use a company’s income statement. Operating expenses are typically divided into three categories: selling, general and administrative expenses (SG&A); cost of goods sold (COGS); and depreciation and amortization expense.
- To calculate SG&A costs, add up all the costs associated with running the day-to-day operations of your business, such as rent, utilities, salaries, and office supplies.
- To calculate COGS, add the costs of all the raw materials and components used to produce your product or service.
- To calculate depreciation and amortization expenses, add up the costs of all the long-term assets that are used in your business, such as buildings, machinery, and vehicles.
How to Calculate Operating Expenses
To calculate your operating expenses, add SG&A, COGS, depreciation, and amortization expenses for a given period. This will give you your total operating expenses for that period.
Here’s another way to calculate OPEX:
Depending on the company, operating expenses can differ significantly. For example, some businesses have expenses that other companies don’t due to the variance in types of operations. With that said, here’s a general formula on how to compute operating expenses and to calculate typical operating costs:
Operating Expenses Formula
Operating Expenses = Payroll/Wages + Sales Commissions + Marketing/Advertising Costs + Rent + Utilities + Insurance + Taxes
This formula should give a good starting point for understanding your company’s operating expenses. Of course, you’ll need to adjust it as needed to account for your company’s unique expenses. But this should give you a good foundation for understanding and managing your company’s operating costs.
Operating expenses can also be expressed as a percentage of sales. This is known as the operating expense ratio (OER). To calculate the OER, divide operating expenses by total sales.
(COGS + OPEX) / Total Sales = OER
For example, if a company has operating expenses of $100,000 and total sales of $1 million, its OER would be 10%.
Operating expenses can be a useful tool for businesses of all sizes. They help track your progress and make necessary adjustments to improve your bottom line.
How to Reduce Operating Expenses in a Business
Reducing operating expenses is important to creating and maintaining a successful business. It can lead to lower costs, improved efficiency, and increased profits when done effectively.
Here are a few ways to reduce your operating expenses:
- Streamline Your Processes: Eliminate unnecessary steps or processes from your business operations. Look for ways to simplify or automate tedious tasks wherever possible.
- Negotiate Better Prices: Negotiate lower prices with vendors and suppliers. See if you can get discounts for bulk buying or negotiate rate reductions.
- Cut Unnecessary Expenses: Analyze your expenses and find areas where you can reduce or eliminate spending. Consider cutting back on unneeded services, subscriptions, or supplies.
- Utilize Technology: Invest in technology that can save you money in the long run. Automate tasks and procedures, or switch to digital tools that save time and money.
- Reduce Energy Costs: Install energy-efficient equipment, use LED lighting, and look for other ways to reduce energy costs.
These are just a few suggestions for reducing operating expenses and improving your business’s bottom line. With some research and planning, you can find even more ways to save money without sacrificing quality or efficiency. The key is to be willing to make changes and focus on reducing costs wherever possible. Doing so can help you keep your business profitable and successful for years to come.
CapEx vs OpEx
CapEx and OpEx are two common terms used to describe how a company invests in its growth and operations.
CapEx, or Capital Expenditures, refers to investments that create long-term value, such as copyrighting software, patenting new ideas, or purchasing major systems. These expenses usually require large upfront investments but may result in substantial long-term gains.
On the other hand, OpEx, or Operational Expenditures, are typically smaller investments made to support daily operations such as purchasing office supplies or paying employee salaries. These expenses are often recurring and require fewer upfront costs.
Frequently Asked Questions About Operating Expenses
Several questions often arise about operating expenses, so we’ve answered the most common ones here.
What Are the Two Main Types of Operating Expenses?
Operating expenses can broadly be classified into two types:
- Fixed costs
- Variable costs
What Are Operating and Non-Operating Expenses?
Operating expenses are the costs associated with running a business daily. They include rent, utilities, payroll, and inventory costs. With this in mind, a low employee turnover rate, efficient equipment, and inventory control management are essential.
Non-operating expenses are costs that are not directly related to the business’s day-to-day operations. They include restructuring costs and obsolete inventory (products you can no longer sell).
How Do You Record Operating Expenses?
There are a few different ways to record operating expenses. The most common method is to track them as they are incurred. This means that you will have a separate category for each type of expense, and you will track the amount spent in each category separately.
Another way to record operating expenses is to lump them into one general category. This is helpful if you want an overall picture of your spending, but it isn’t easy to track specific expenses.
No matter which method you use, keeping accurate records of your operating expenses is important. This information helps ensure your business runs efficiently and within its budget.
What Is the Difference Between Cost and Expense?
Cost refers to the amount of money spent on creating or acquiring something. On the other hand, the expense is the amount of money paid to keep something running or operational.
Costs are always upfront, while expenses are ongoing. For example, the cost of buying a new car includes the price of the vehicle and any taxes and fees. The expense of owning a car includes things like gas, insurance, and maintenance.
Is Interest Expense an Operating Expense?
Financing costs are unrelated to a company’s day-to-day operations and are not considered operating expenses. Interest expense is not an operating expense. This is because interest expense is a financing cost incurred when a company borrows money.
Operating expenses can be a major factor in the success or failure of a business. By understanding your operating expenses and taking steps to keep them low, you can put yourself in a better position for long-term success.
What Is Pre Operating Expenses
Pre-operating expenses refer to the costs that a business incurs before it begins its regular operations, such as startup and capital costs. These expenses are usually spread out over some time. They include the costs associated with designing the business, hiring employees, purchasing equipment, obtaining licenses and permits, developing a marketing plan, and other business-related activities.
What Are Selling Expenses?
Selling expenses are the costs incurred in the process of selling products or services, and may include a variety of expenses such as advertising, sales commissions, travel expenses for meeting with clients, salaries for sales employees, and office supplies and equipment used for sales.
Additionally, indirect selling expenses such as rent, utilities, and other administrative costs associated with selling goods and services may also be included in the calculation. These indirect costs are not directly related to the sale of goods or services, but are still considered a part of selling expenses because they support the overall sales process.
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