Operating expenses play an important role in your business. Often abbreviated to OpEx, they encompass everything from paying the bills to keeping the lights on at your premises to covering staff wages. They keep the wheels of your business in motion and can significantly impact your bottom line.
What is an operating expense?
An operating expense refers to the cost of doing business. It covers any cost incurred through your day-to-day, regular business operations.
Examples of operating expenses
Operating expenses are categorised differently from business to business. For example, a company focused on developing new pharmaceuticals could classify research and development (R&D) costs as operational — they're an essential part of the day-to-day business.
However, a retail business looking to enter the market with a new product wouldn't categorise R&D as an operating expense — it's not a core part of their general operations.
Profit and loss (P&L) statements generally split operating expenses into these categories:
Overheads
Core operating costs not directly linked to the output of products or services. They include rent, utilities and insurance.
Cost of goods sold (COGS)
Costs directly related to providing products or services. They include inventory, shipping, storage and labour costs.
Sales, general and administrative (SG&A)
Expenses not directly tied to your product or service. SG&A includes advertising, sales commissions, business travel, marketing and administration costs.
Depreciation and amortisation
Expenses linked to the diminishing value of your business's tangible (depreciation) and intangible (amortisation) assets. This loss in value is recorded as an operating expense.
Miscellaneous
Smaller, incidental purchases essential to operations. They include office supplies, minor equipment repairs and any postage or shipping (outside of providing a product).
Managing operating expenses
Managing operating expenses effectively can boost your bottom line. Reducing operating costs can increase profitability, but it has downsides if you cut costs indiscriminately. Your business may suffer long-term if you compromise on the quality of your product or service or reduce your staff numbers. To manage operating expenses effectively:
1. Review expense categories regularly
Keep a close eye on operating expenses, set a realistic budget, and review any discretionary spending.
2. Identify opportunities for change
Explore ways to bring your product or service to market more efficiently. Audit existing supplier contracts and try to negotiate more favourable terms.
3. Look to technology
Consider using a cloud-based business management platform to integrate workflows, streamline and automate processes. It’ll save time and money, too.
4. Reassess the staffing status quo
Consider outsourcing work, or implementing work-from-home policies where practical to reduce office overheads.
What are non-operating expenses?
Non-operating expenses are costs not directly associated with the day-to-day running of the business. They don't occur regularly or directly contribute to core operations.
Examples of non-operating expenses
Some common examples of non-operating expenses are:
Interest expenses
The cost of borrowing money through loans, bonds, or other forms of debt.
Losses from the sale of assets
When you sell equipment or property at less than its book value.
Restructuring costs
If your business loses money from restructuring, it’s considered a non-operating expense.
Inventory write-offs
When a product is unsellable, obsolete or no longer worth anything.
Foreign exchange losses
Fluctuations in exchange rates that result in a loss.
Incidents or disasters
Losses (and related costs) from isolated incidents or natural disasters are non-operating expenses.
Operating expenses (OpEx) vs capital expenditures (CapEx)
The main difference between operating expenses and capital expenditure is their terms of use. Operating expenses are day-to-day costs, whereas capital expenditure refers to significant investments that'll provide long-term benefits to the business.
Key differences between OpEx and CapEx:
OpEx
Ongoing, day-to-day cost
Regular part of operations
Have an impact on net income
CapEx
Long-term investment
One-time asset purchase
Affect the balance sheet by increasing asset value
Fixed and variable costs
Operating expenses fall into two categories: fixed and variable. Fixed costs, like rent, salaries and insurance, won't fluctuate if your production or sales go up or down. Variable costs fluctuate as a direct result of business outputs. For example, your inventory costs may increase as you sell more products. Further your labour costs and sales commissions may increase.
Fixed costs - remain the same for a fixed period.
Variable costs - fluctuate based on production and sales of products or services.
Importance of understanding business operating expenses
Increased operating expenses mean less bottom-line profit for a business, and reduced operating expenses can lead to a direct increase in profit. Profit aside, there are also legal and tax obligations to consider. Make sure you correctly report operating costs and understand their impact on tax obligations.
Higher OpEx = lower profits
Incorrect reporting = under or overpayments in tax
With a clear understanding of operating expenses, businesses can understand the revenue required to cover base costs and make a profit.
Operating expenses FAQs
Are salaries and wages considered operating expenses?
Yes, salaries and wages are operating expenses as they form part of the day-to-day costs of running a business. An exception to this is expenses relating to overtime or freelance work.
What are three common operating expense categories?
The three most common categories of operating expenses are overheads, general and administrative costs, and costs of goods sold.
Where do operating expenses go on a balance sheet?
Operating expenses sit under the liabilities category on a balance sheet.
What is an operating expense ratio, and how is it calculated?
The operating expense ratio (OER) measures financial efficiency and shows how much a business must spend to generate income. The calculation is:
(operating expenses + cost of goods sold) / net sales = operating ratio
What is a healthy operating expense ratio?
Generally, the lower your operating expense ratio the better, as it signifies how efficiently you’re able to generate revenue relative to your expenses. Typical OERs sit between 60-80%, with below 70% considered a healthy OER. However, this ratio may vary by industry. Further, even if your OER is good, it’s important to follow whether it’s tracking up or down over time.
Understand, optimise and succeed
A clear picture of your business's operating expenses is critical to success. They indicate the base-level costs you need to cover to keep the wheels in motion and can clarify where to make changes to drive efficiencies and increase profits.
With MYOB's advanced reporting capabilities, you can track operating expenses quickly and accurately to make informed decisions for long-term success. Get started with MYOB today!
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