Every business has or should have a section in the company’s income statement that is dedicated to operating expenses. If it does, and as a worker, you don’t actually understand what it means and why there are separate from other items on your income statement, we are here to give you a guide on everything you need to know.
What is Operating Expenses?
These are expenses that are incurred in order to keep the business running, such as staff wages and office supplies. Note that operating expenses do not include the cost of goods sold (materials, direct labor, manufacturing overhead) or capital expenditures (larger expenses like buildings or machines).
Understanding Operating Expenses
Most businesses cannot do without operating expenses and some firms smartly reduce their operating expenses in order to gain a competitive edge and increase their earnings. In as much as reducing operating expenses comes with some gains, it is not all rosy, as sometimes reducing operating expenses can also compromise the integrity and quality of operations. Thus, finding the right balance is necessary even though it can be difficult, but then it can yield significant rewards.
The Internal Revenue Service on their end (IRS) gives businesses access to deduct operating expenses if the business operates to earn profits. Howbeit, the IRS and most accounting principles differentiate between operating expenses and capital expenditures.
Importance of Operating Expenses
As a business owner, these are some of the reasons why reducing operating costs might be your best option:
- Try increasing the price of your product or service to increase revenues, even though customers may not be willing to pay more.
- Try decreasing your COGS by using cheaper labor or materials, but note that the quality of your service/product may suffer leading to a decline and loss of business.
Understand also, that operating expenses typically do not directly impact price or quality. Thus controlling operating expenses can improve your bottom line without making your product become worse, this means you can keep more cash in your business.
What will you Find in Operating Expenses?
The following is included in operating expenses:
- Accounting fees
- Attorney fees
- Building maintenance and repairs
- Payroll for staff (excluding labor for manufacturing)
- License fees
- Marketing (including social channels like Facebook)
- Office supplies
- Property taxes on real estate
- Vehicle expenses
- Travel expenses
What Does an Increase in Operating Expenses Mean?
When they say there is an increase in expenses, it simply means less profit for a business. Companies usually monitor operating expenses, because these types of costs may be less fixed than their non-operating expenses, manufacturing costs as well as capital expenses.
What Does Non-Operating ExpensesMean?
A non-operating expense is one that is not linked to a company’s daily business operations or manufacturing. These include costs for:
- Currency exchange fees
- Obsolete inventory
- Bank charges
- Payments for lawsuits and associated fees
- Restructuring costs.
Operating Expense Ratio
The operating expense ratio (OER) is the cost of operating a piece of property compared to the income that the property makes. This ratio is a popular one to use in real estate like with companies that rent out units. A low OER implies that less money from income is being spent on operating expenses.
OER can also come in handy in gauging the difference in operating costs between two properties.
Examples of Operating Expenses
Examples of office-related expenses
- Office supplies
- Insurance costs
- Accounting expenditures
- Depreciation of fixed assets assigned to non-production areas
- Insurance costs
- Legal fees
- Property tax
- Utility costs
- Repair cost for non-production facilities
- Rent costs for non-production facilities.
Examples of sales and marketing-related operating expenses
- Sales material costs
- Travel costs
- Advertising costs
- Direct mailing costs
- Entertainment costs
Examples of compensation-related operating expenses
- Non-production employees benefits.
- Non-production employees pension plan contributions.
- Non-production employee’s compensation and related payroll tax expenses.
- Sales commissions.