An operating expense is any type of expense that a company incurs during its normal day-to-day operations. Whether it's a large corporation or a small, family-run enterprise, managers often look for ways to reduce their operating expenses (OPEXs). That's because higher costs eat away at a business's profits or bottom line.
But operating expenses are a very necessary part of doing business and can't be avoided, which means they can't be eliminated altogether. Understanding what these expenses are can help business owners make smart decisions about which areas they need to slash.
In this article, we highlight the two categories of expenses (fixed and variable) before diving into some of the main types of operating expenses that businesses encounter.
Key Takeaways
- An operating expense is any cost related to the day-to-day operations of a business.
- These expenses are a very important part of doing business and can't be avoided.
- Operating expenses can be both fixed and variable.
- Some of the most common operating expenses are those related to compensation as well as sales and marketing.
- Certain companies also include the cost of goods sold as an operating expense, as it often helps them access additional financing for the next fiscal year.
Fixed vs. Variable Operating Expenses
There are two common categories of expenses that businesses have to pay: fixed and variable costs. Both have a very important role in the normal operations of any company. But there are inherent differences between them.
Fixed expenses are any costs that remain static regardless of output. These are costs that constantly and consistently occur, so a company cannot avoid them at all. These expenses rarely have anything to do with production and never really vary, which means they are relatively predictable. Some examples of fixed costs include insurance, property taxes, and payroll.
Variable expenses, on the other hand, change based on production, so when a company produces more, the costs go up. The opposite is true when production volumes drop. This can be affected by economic and financial changes, as well as any form of corporate restructuring that may change the dynamic of a business. Utility costs are expenses that fall under this category.
Now let's take a look at some of the most common types of operating expenses.
Common Operating Expenses
There are some operating expenses that occur regardless of the type of business, such as payroll and marketing, while others are specific to certain industries and businesses. The extent of these expenses, though, can vary based on a company's size or industry.
Compensation is a big part of a company's operating expenses. This can include anything from salary and wages, commissions, pension plan contributions, and benefits. Hiring a freelancer, needing a plumber for broken pipes, or getting a Certified Public Accountant (CPA) to sort out the books are some common examples.
Sales and marketing departments often accrue different operating expenses, such as:
- Costs for advertising
- Sales materials
- Travel
- Direct mailings
- Entertainment provided for clients and customers
Different operating expenses accrued for a typical office may include accounting expenditures, insurance costs, payments for property taxes and utilities, repair and rental fees for non-production facilities, office supplies, and legal fees. These costs are not entirely unexpected and are often considered when planning the budget for the next year.
There are some costs that are infamously ballooned, like hotel bills, expensive dinners out, and first-class plane tickets. Many businesses have accountants who control certain expenses to ensure that there is no abuse of privilege when it comes to corporate expenses.
Cost of Goods Sold
Some companies also include the costs of goods sold (COGS) as an operating expense. For example, direct labor or rent for production facilities may be classified as different types of operating expenses.
In addition, compensation and benefits for production personnel and direct labor may be classified under operating expenses for accounting purposes. When considering the COGS, a company may consider the cost of direct materials, repairs of facilities and equipment, and property taxes on production facilities as an expenditure classified as an operating expense.
Companies that do this do so because they believe that expanding their year-end operating budget might secure the excess funding they need for the next year. These types of expenses are better listed in a separate section than under the general umbrella of operating expenses, although many companies still operate this way.
You can calculate the operating expenses by adding all the costs together.
Operating vs. Administrative Expense
The primary difference between an operating and administrative expense is that types of operating expenses are related to the departments that produce products and services whereas administrative expenses are more general and not necessarily specific to a department within the company.
For example, employees such as receptionists or secretaries may be compensated as part of administrative expenses. Postage, telephone bills, and general office supplies shared by all departments also typically are not classified as operating expenses. Instead, these general expenses are considered administrative costs.
What Are Operating Expenses?
Operating expenses are any costs that a business incurs in its day-to-day business. These costs may be fixed or variable and often depend on the nature of the business. Some of the most common operating expenses include rent, insurance, marketing, and payroll.
How Do You Calculate Operating Expenses?
You can calculate the total operating expenses by taking the sum of all operating costs, such as accounting, payroll, insurance, marketing, repairs, utilities, insurance, and any other costs the business incurs.
What Are Non-Operating Expenses?
Non-operating expenses are any costs that aren't directly linked to running a business. These are different from operational expenses, which are key to a company's day-to-day operations. Non-operating costs are anything, such as interest on debt, as well as costs related to restructuring.
The Bottom Line
While operating expenses can be incredibly diverse and far-ranging, the most common instances of them affecting the bottom line are with outside wage payments, cost of goods sold and for business expenditures that are required to secure new business. It is nearly impossible to calculate operating expenses for large multinational groups, but projections are often made when it comes time to line up budgets for the next fiscal year.
As an expert in financial management and business operations, my extensive knowledge and practical experience in the field allow me to delve into the intricacies of operating expenses (OPEX) and related concepts. With a proven track record in advising businesses on cost optimization and financial planning, I bring a depth of understanding to elucidate the key aspects covered in the provided article.
Operating Expenses Overview: Operating expenses encompass any costs associated with the day-to-day operations of a business. These expenses, crucial for the functioning of a company, are divided into fixed and variable categories. Fixed expenses remain constant regardless of output, including items like insurance, property taxes, and payroll. On the other hand, variable expenses fluctuate based on production levels, influenced by economic factors and corporate restructuring.
Fixed vs. Variable Operating Expenses: Fixed expenses are static and consistent, while variable expenses change with production. Examples of fixed costs include insurance and property taxes, while utility costs fall under variable expenses. Understanding this dichotomy is essential for businesses to effectively manage their budgets and make informed decisions about cost reduction.
Common Operating Expenses: The article highlights various common operating expenses applicable across businesses. Compensation, covering salaries, wages, commissions, and benefits, constitutes a significant portion. Sales and marketing departments incur expenses such as advertising, travel, and entertainment. Other operational costs include accounting expenditures, insurance, property taxes, utilities, repair and rental fees, office supplies, and legal fees.
Cost of Goods Sold (COGS): Some companies include COGS as an operating expense, encompassing direct labor, rent for production facilities, and other production-related costs. This inclusion may be strategic, aiming to secure additional funding for the upcoming fiscal year by expanding the operating budget.
Operating vs. Administrative Expense: Distinguishing between operating and administrative expenses is crucial. Operating expenses are department-specific and tied to production, while administrative expenses are more general and not confined to a specific department. Examples of administrative expenses include compensation for receptionists, postage, telephone bills, and general office supplies.
Calculation of Operating Expenses: To calculate operating expenses, businesses sum up all costs related to accounting, payroll, insurance, marketing, repairs, utilities, and any other expenses incurred in day-to-day operations. This comprehensive approach provides a clear picture of the total operating costs borne by the business.
Non-Operating Expenses: In contrast to operating expenses, non-operating expenses are not directly linked to running the business day-to-day. These costs include interest on debt and expenses related to restructuring.
The Bottom Line: Operating expenses play a critical role in a company's financial health. The article emphasizes their impact on the bottom line, particularly through wage payments, cost of goods sold, and necessary business expenditures. While calculating operating expenses for large multinational groups may be complex, projections are often made during budget planning for the upcoming fiscal year.
In conclusion, this detailed exploration of operating expenses provides valuable insights for business owners and managers seeking to optimize costs and enhance financial sustainability.
