Operating Expenses

What are Operating Expenses (OpEx)?

Operating expenses (OpEx) are the costs associated with a company’s day-to-day operational activities that aren’t directly tied to the production of goods or services. They include a wide array of expenses, including rent, payroll, marketing, R&D, maintenance, utilities, and legal fees.

OpEx is a crucial part of financial analysis. It helps businesses understand their primary cost drivers and plays a key role in calculating operating profit — the difference between a company’s gross profit and its operating expenses before interest and taxes.

Its significance, however, extends beyond cost management. It offers a lens through which business leaders can gauge their overall operational efficiency and revenue-generating capacity. Relatively speaking, a higher OpEx as a percentage of sales indicates less efficiency in generating those sales.

Synonyms

• Operating expenditures
• Operating costs
• OpEx

Types of Operating Expenses

Certain types of operating expenses — like payroll and marketing — apply across the board, regardless of the type of business. Others are specific to particular industries or businesses. For example, a construction business will incur expenses for tools and machinery, while a software company will have high research and development costs.

Here’s a look at 10 common examples of operating expenses:

1. Selling, General, and Administrative Expenses (SG&A)

SG&A expenses include the costs associated with selling a product or service. The two main categories are sales/marketing and general/administrative.

• Sales and marketing — Costs related to advertising, promotional materials, sales staff salaries, commissions, and business travel expenses.
• General and administrative — Salaries of non-sales personnel, office supplies, legal and professional fees, insurance, and utilities.

2. Research and Development (R&D)

R&D expenses are costs your business incurs while developing new products or services. They include:

• Salaries of R&D staff
• Prototype materials
• Research costs (trials, tests, market research)
• Patent applications
• Software development

3. Manufacturing and Production Costs

For accounting purposes, B2B manufacturers sometimes consider certain direct and indirect expenses as operating expenses instead of costs of goods sold (COGS). The boundary between these two categories can be blurry, as some production-related costs can be classified as either.

As a general rule of thumb:

• COGS = variable costs
• OpEx = fixed costs

There are some instances where this is different, though. When considering COGS, the following expenditures may fall under OpEx instead:

• Compensation and benefits for production workers
• Direct materials costs
• Machinery repair and maintenance
• Property taxes on production facilities

If they do this, it’s because they want to expand their year-end operating budget to secure more funding for the coming year. It’s worth mentioning these expenses generally are better in a section outside the general operating expense umbrella, but plenty of companies don’t bother to distinguish between production costs and others.

4. Rent, Utilities, and Office Expenses

Rental payments for office space, warehouses, or retail locations fall under the OpEx category. Utilities like electricity, water, and internet services also do. Miscellaneous ad-hoc purchases like office supplies, equipment, and furniture also count as operating expenses.

5. Depreciation and Amortization

Depreciation is an accounting method that allocates the cost of a tangible asset over its useful life. Amortization is similar but applies to intangible assets like patents or trademarks.

As a simple example:

• A company purchases a delivery truck for $50,000, expecting it to last for 10 years. The cost of the truck will be spread out over its useful life, resulting in an annual depreciation expense of $5,000.
• A company acquires a patent for its new technology for $20,000, with an estimated useful life of 8 years. This results in an annual amortization expense of $2,500, reflecting the allocation of the patent’s cost over its useful lifespan.

Depreciation and amortization are non-cash expenses, meaning they don’t involve actual cash outlays, but rather reflect the gradual consumption of a long-term asset. They reduce a company’s taxable income as well, which makes them an important consideration for tax planning.

6. Transportation and Travel Costs

Transportation and travel expenses are common operating costs. They may include:

• Business travel (flights, car rentals, hotels)
• Per diems
• Shipping and delivery fees
• Gasoline or diesel fuel for company vehicles
• Company vehicle leases or purchases

7. Employee Salaries and Benefits

Employee salaries and benefits make up one the largest portion of the average business’s operating expenses. Salaries, wages, and bonuses all fall under this category. All the benefits you offer — e.g., medical insurance, retirement benefits, and education/professional development programs — are also included here.

8. Insurance Premiums

As a business owner, you need insurance to protect your company from various risks. Premiums for general liability, product liability, and professional liability policies are all operating expenses — as are property insurance and workers’ compensation premiums.

9. Maintenance and Repairs

Costs associated with maintaining and repairing business equipment, vehicles, and facilities are operating expenses. They may include:

• Regular maintenance (e.g., oil changes, tune-ups for company vehicles)
• Upgrades and repairs
• Emergency or unexpected repairs (e.g., fixing a broken water pipe in the office)

10. Taxes, Licenses, and Permits

Property taxes, sales taxes, and business licenses for your company are all considered operating costs. Regulatory fees, such as environmental permits for certain industries or professional licenses that require renewals, also belong here.

How to Calculate Operating Expenses

Calculating operating expenses requires you to summarize all costs associated with your business’s day-to-day operations, excluding expenses related to production (cost of goods sold, or COGS) and capital expenditures (CapEx).

The formula for calculating operating expenses varies slightly depending on the specifics of your business and the nature of your expenses.

A general approach is as follows:

Operating Expenses = SG&A (Selling, General & Administrative Expenses) + Depreciation + Amortization + Other Operating Expenses

“Other Operating Expenses” could include dozens of other costs — R&D, property taxes, permits, insurance premiums, employee salaries and benefits, and so on.

To calculate your business’s operating expenses, add up all the relevant costs for a given period (typically one year). If you want to understand your average daily or monthly cost, divide the yearly value by the 365 (days) or 12 (months).

Alternative Method: Using the Income Statement

You can also use the income statement to tally up your operating expenses. After calculating your COGS and gross profit, you’ll deduct operating expenses to find your operating income.

As you enter each operating expense on your income statement, it’s important to categorize each so you know where the majority of your costs are coming from. By looking at operating expense this way, you have a clear view of how they impact your company’s overall profitability.

Let’s say your company has net sales of $125 million, with COGS totaling $70 million, and operating expenses totaling $28 million.

The operating income would then be calculated as:

$125 million (net sales) – $70 million (COGS) – $28 million (Operating Expenses)

The result is $27 million of operating income. In other words, your company made $27 million before accounting for taxes and interest and OpEx accounts for 22.4% of your total costs.

Calculating Your Operating Expense Ratio

The operating expense ratio (OER) is a crucial aspect of financial analysis. It gives you insights into operational efficiency and cost management relative to revenue.

To calculate it, use the following formula:

OER = (Operating Expenses / Net Sales) × 100

Where:

• Operating expenses include all costs related to running the business, such as salaries, rent, utilities, insurance, and marketing expenses.
• Net sales refer to the revenue generated from business operations, adjusted for returns, allowances, and discounts (also called operating revenue).

For example, if a company has operating expenses of $100,000 and net sales of $500,000, its OER would be calculated as follows:

OER = (100,000 / 500,000) × 100

OER = 20%

A lower OER indicates a higher operational efficiency, suggesting the company is generating a larger amount of revenue for each dollar of operating expense. Conversely, a higher OER may point to potential inefficiencies or a need for cost management improvements.

In the example above, an OER of 20% means that for every dollar in net sales, the company spends 20 cents on operating expenses.

Differentiating Operating Expenses from Other Expenses

Operating Expenses vs. Non-Operating Expenses

Non-operating expenses are costs you incur outside of normal business operations. They include:

• Interest payments on debt
• Losses from investments
• Corporate restructuring costs
• Lawsuit settlements

While operating expenses are essential for running the business and generating revenue, non-operating expenses arise from financial activities and other external factors that aren’t directly linked to the production or delivery of your products or services.

The biggest reason you need to make this distinction is that non-operating expenses do not affect your operating income — while they may decrease your net income, they don’t directly impact operational efficiency and profitability.

A large lawsuit or strategic realignment, for instance, will only skew your financials for the period in which it occurred if you don’t separate it from the costs of actually running your business.

Operating Expenses vs. Capital Expenditures

Capital expenditures (CapEx) are the funds your company uses to acquire, upgrade, and maintain physical assets like property, plants, or equipment (PP&E). Capital expenses are usually long-term investments that will benefit the business in the future. 

The primary difference between OpEx and CapEx lies in their impact on a company’s financial statements and cash flow. OpEx reduces the company’s earnings in the period they occur, directly impacting the operating income and net income reported on the income statement.

Unlike operating expenses, capital expenditures are not expensed immediately on the income statement. Instead, they are capitalized and reported on the balance sheet as an asset. They’re then depreciated or amortized over their useful lives, spreading the asset’s cost over the period it’s expected to generate revenue for the company.

Operating Expenses vs. COGS (Cost of Goods Sold)

Cost of goods sold (COGS) is the accumulated direct costs associated with producing the goods or providing the services your company sells. It includes materials and labor directly involved in the product’s creation or service’s provision.

As far as production-related expenses, some fall under operating expenses, and others fall under cost of goods sold (COGS). The main difference is that COGS is mostly variable, while OpEx is typically fixed. Fixed costs remain the same even if production or sales increase, while variable costs are directly linked to operational output (and, by extension, gross margin).

For example, rent, utilities, and property taxes are fixed, so they’re considered operating expenses. They impact the company’s operational efficiency and net profit margins over a longer term.

How to Control Operating Expenses

Controlling your operating expenses requires you to (a) understand the nature and components of your operating expenses, (b) closely monitor them on a regular basis, and (c) implement strategies to reduce or optimize costs where possible.

Some ways to control your operating expenses include:

• Reviewing and renegotiating contracts with suppliers, vendors, and service providers for lower rates or better terms
• Investing in new technology and equipment to improve efficiency and reduce labor costs
• Implementing cost-saving measures like energy-efficient practices, paperless operations, and telecommuting options for certain employees
• Optimizing staffing levels for demand fluctuations (and potentially outsourcing certain functions)
• Controlling inventory levels to avoid overstocking and minimize holding costs (for manufacturers and retailers)
• Tracking and managing your customer acquisition cost (CAC) and working toward sales efficiency (for SaaS companies)

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