7 Min. Read
March 23, 2023
One of the responsibilities of management is determining how to reduce operating expenses without affecting the ability to compete with competitors. Understanding operating expenses and how they impact your business are crucial skills. Use this guide to learn how to identify, track, and manage operating expenses to benefit your company’s continued growth and financial health.
Key Takeaways
- Insurance, license fees, rent, property taxes, and travel expenses are common examples of operating expenses.
- An increase in operating expenses means less profit for a business.
- Operating expenses aren’t included in COGS because they are the cost of daily operations and are not related to the production of a product or service.
- Full-time salaries and hourly wages are considered expenses, but the cost of hiring labor to produce products is calculated separately under COGS.
Here’s What We’ll Cover:
What are Operating Expenses?
What Is Included in Operating Expenses?
What Does an Increase in Operating Expenses Mean?
What Are Non-Operating Expenses?
Operating Expense Ratio
Are Wages Operating Expenses?
Operating Expenses and Capital Expenditures
Importance of Operating Expenses
Conclusion
Frequently Asked Questions
NOTE: FreshBooks Support team members are not certified income tax or accounting professionals and cannot provide advice in these areas outside of supporting questions about FreshBooks. If you need income tax advice, please contact an accountant in your area.
What are Operating Expenses?
Operating expenses are expenses a business incurs to keep running, such as wages and supplies. They do not include the cost of goods sold (materials, direct labor, manufacturing overhead) or capital expenditures (larger expenses such as buildings or machines).
What Is Included in Operating Expenses?
Think of operating expenses as the cost a business incurs for doing business — they’re part of a business’s core operations. They vary based on the structure of the company. Operating expenses are reflected on a company’s income statement.
Operating expenses include:
- Payroll for staff (excluding labor for manufacturing)
- Insurance
- License fees
- Rent
- Research
- Marketing (including for social channels like Facebook)
- Accounting fees
- Building maintenance and repairs
- Office supplies
- Utilities
- Attorney fees
- Property taxes on real estate
- Vehicle expenses
- Travel expenses
Operating Expenses Examples
Below are some examples of what could be considered operating expenses:
- Compensation and any related payroll tax expenses for any non-production employees like sales reps, front-of-house staff, receptionists, or administrative staff.
- Benefits provided to non-production employees, including insurance, retirement funds, and PTO expenses.
- Office supplies and administrative expenses required for the company’s daily operations, such as printer paper, pens, computers, telephone lines, or office furniture.
FreshBooks expense tracking software can help businesses efficiently track and categorize their operating expenses, such as rent, utilities, insurance, and travel expenses. This feature helps businesses stay on top of their operating expenses, monitor their cash flow, and identify areas where they can reduce costs. It can also automatically organize categories such as office expenses, travel expenses, and equipment expenses. Our expenses tracking feature helps you save time and reduces the risk of errors. Click here to sign up for your free trial.
What Does an Increase in Operating Expenses Mean?
An increase in operating expenses and overhead costs means less profit for a business. They receive the most scrutiny from a company, as these costs may be less fixed than their non-operating expenses, manufacturing costs, and capital expenditures.
A company’s senior management tries to reduce operating expenses and utility costs by outsourcing areas of the business or allowing some of the existing staff to work from home. This cuts down on the actual physical space needed for staff at the office. Management also implements money-saving techniques such as automating parts of the business or reducing salaries for new hires.
What Are Non-Operating Expenses?
Non-operating expenses are unrelated to a company’s day-to-day business operations or manufacturing. Non-operating expenses include costs for:
- Depreciation
- Amortization
- Bank fees (including interest charges)
- Lawsuit payments and associated fees
- Currency exchange fees
- Restructuring costs
- Obsolete inventory (products that can no longer be sold)
Operating Expense Ratio
The operating expense ratio (OER) is the cost of operating a piece of property compared to the income the property brings in. It’s a very popular ratio for real estate, such as with companies that rent out units. A low OER means less money from income is being spent on operating expenses.
OER can also be used to gauge the difference in operating costs between two properties. For instance, if a company owns two similar plants in Michigan with similar outputs, and one’s OER is 15% more than the other, management should investigate why.
Operating Expenses and Capital Expenditures
Capital expenditures include long-term investments such as purchasing a new building, production machinery, or patents. They are major purchases made by the company and used over a long period of time. Think of capital expenditures as long-term assets that increase the company’s productivity, output, or performance over several years.
Operating expenses typically include supplies, advertising expenses, administration fees, wages, rent, and utility costs. It’s important to pay attention to the distinction between operating expenses and capital expenditures, especially in regards to capital or physical asset-related costs, since the two expenditures are treated differently for accounting purposes.
Importance of Operating Expenses
Operating expenses are important because they help assess a company’s costs, reduce operating costs, and stock management efficiency. Essentially, they highlight the level of cost a company needs to make to generate revenue, which is ultimately the main goal of any business. When a business doesn’t successfully track its operating expenses, it can end up losing money on spending oversights. Diligent accounting of operating expenses keeps profits on growth for continued success.
Conclusion
Understanding operating expenses is vital for you to keep accurate accounting records and stay focused on keeping your business profitable and strong. More overhead costs and operating expenses mean less profit for your business. By tracking operating expenses accurately and quickly, you can make informed, forward-thinking decisions that help you scale and succeed long-term.
FAQs on Operating Expenses
Is Income Tax Expense an Operating Expense?
No, income tax expense is considered a non-operating expense and should not be included when calculating operating expenses for a business.
Is Operating Expense a Liability or Asset?
Operating expenses are represented on a balance sheet as a liability. Because they are a financial expense that does not directly contribute to selling services or products, they aren’t considered assets.
Is Operating Expense Fixed or Variable?
Operating expenses can be either fixed or variable. Most operating costs are considered variable costs because they change with the production level or size of the business.
How do Operating Costs Affect Profit?
Operating expenses differ by industry and how a company decides to operate based on its business model. As a general rule, an increase in any type of operating costs lowers profit.
Are Operating Expenses Included in COGS?
No, operating expenses and cost of goods sold are shown separately on a company’s income statement. This is because the cost of goods sold is directly related to the production of a product, as opposed to daily operations.
Are Wages Operating Expenses?
Administrative expenses such as full-time staff salaries or hourly wages are considered part of a company’s operating expenses. The costs for hiring labor to produce a product are calculated separately under the cost of goods sold.
The average company spends 5 hours each pay period or 21 days each year on payroll processing. Simplify your payroll process and save time issuing payments. FreshBooks offers customizable payroll software that lets you track and manage payroll.
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As an expert in accounting and financial management, I bring a wealth of experience and knowledge to the discussion of operating expenses. Throughout my career, I have actively participated in advising businesses on optimizing their financial health, including strategies for reducing operating expenses without compromising competitiveness. My deep understanding of accounting principles and hands-on experience in financial management positions me well to elucidate the concepts discussed in the article.
Operating Expenses Overview: Operating expenses are fundamental to a business's functionality, encompassing various costs incurred to sustain day-to-day operations. Contrary to the cost of goods sold (COGS) and capital expenditures, operating expenses are distinctively related to a company's core operations.
Components of Operating Expenses: Operating expenses encompass a broad spectrum of costs, reflective of a company's daily operations. These include payroll for staff (excluding manufacturing labor), insurance, license fees, rent, research, marketing, accounting fees, building maintenance, office supplies, utilities, attorney fees, property taxes, vehicle expenses, and travel expenses.
Impact of Increased Operating Expenses: A surge in operating expenses directly translates to reduced profitability for a business. The scrutiny these costs receive is heightened, as they often represent variable expenses that can be subject to optimization strategies. Senior management commonly seeks methods such as outsourcing, remote work arrangements, and automation to mitigate rising operating costs.
Non-Operating Expenses: Distinguished from operating expenses, non-operating expenses are unrelated to daily business operations. These may include depreciation, amortization, bank fees (including interest charges), lawsuit payments, currency exchange fees, and restructuring costs.
Operating Expense Ratio (OER): The operating expense ratio (OER) is a key metric, particularly in real estate, comparing the cost of operating a property to the income it generates. A lower OER signifies a more efficient allocation of income, emphasizing the importance of managing operating expenses in maximizing profitability.
Operating Expenses vs. Capital Expenditures: It is crucial to differentiate between operating expenses and capital expenditures. The latter involves long-term investments, such as buying a new building or machinery, contributing to increased productivity over an extended period. Understanding this demarcation is essential for accurate accounting and financial reporting.
Importance of Operating Expenses: Operating expenses play a pivotal role in assessing a company's costs, enhancing operational efficiency, and managing stock effectively. Diligent tracking of operating expenses is essential for informed decision-making, ensuring sustained profitability and long-term success.
In conclusion, understanding operating expenses is indispensable for accurate financial records and sustained business success. By effectively managing and tracking these expenses, businesses can make informed decisions, optimize costs, and ultimately achieve their financial goals.
