Take a look at your company’s income statement, and you might see a section devoted to operating expenses. Ever wondered what that means and why operating expenses are separate from other items on your income statement? This guide will cover everything you need to know.
What are operating expenses?
Operating expenses may also be known as Selling, General, and Administrative (SG&A) expenses. They’re the costs a company generates that don’t relate to the production of a product.
Operating expenses can really impact the profitability of a business. To understand how, consider the basic formula of a company’s profit and loss statement:
As you can see from the formula above, operating expenses are subtracted from a business’s gross profit, and the result is the company’s operating income.
Why operating expenses are super important
If you’re a business owner wanting to improve the bottom line, you have several options, but reduce operating expenses may be the best one. Here’s why:
You can try increasing the price of your product or service to increase revenues, but customers may not be willing to pay more.
You can try decreasing your COGS by using cheaper labor or materials, but quality may suffer and lead to lost business.
On the other hand, operating expenses typically don’t directly impact price or quality. So controlling operating expenses can improve your bottom line without making your product worse, meaning you can keep more cash in your business.
Examples of operating expenses
Essentially, operating expenses are the costs of keeping the business running, beyond direct materials and labor. Examples of operating expenses include things like:
- Accounting fees
- Advertising and marketing
- Legal fees
- License fees
- Office Supplies
- Maintenance and repairs
- Salaries and wages (other than direct labor for production employees)
- Property taxes
- Vehicle expenses
How to calculate operating expenses
Knowing your operating expenses (OPEX) allows you to calculate your company’s operating expense ratio (OER). The OER gives you a direct comparison of your expenses to your income so that you can compare your business to others in your industry.
(COGS + OPEX) / Revenues = OER
To illustrate, say the financial statements for Carly’s Craft Cottage looked like this in 2019:
|Income Statement Line Item||Amount|
|Cost of Goods Sold||$50,000|
Carly wants to know how her business compares to others in her industry, so she calculates her OER as:
($50,000 + $70,000) / $200,000 = 0.60
So Carly is spending 60 cents of every dollar she earns on the day-to-day costs of running her business. Whether that result is good or bad depends on the norm for her industry.
If you calculate OER for your business, compare it to industry benchmarks. You can usually find industry benchmarks from industry associations, trade organizations, or your chamber of commerce. Watch out for an OER that increases over time. A rising OER may signal a decline in your business’ operating efficiency from year to year, so you’ll want to take a close look at your business operations to determine the cause.
How to find operating expenses
Operating expenses are summarized on a company’s income statement. Every company has different operating expenses based on their industry and setup.
To find your company’s operating expenses, review your general ledger, and look for expenses that don’t directly impact the cost of creating your product or service.
What are non-operating expenses?
Non-operating expenses are expenses a business incurs that aren’t related to its core operations. Some examples of non-operating expenses include:
- Interest expense
- Obsolete inventory charges
- Lawsuit settlements
- Losses from the sale of assets
- Restructuring expenses
Because these items aren’t part of the company’s core activities and may occur infrequently, it’s helpful to separate them from the business’ results of operations.
How to calculate operating expenses on the income statement
Some business owners don’t have an income statement for their business, or their income statement doesn’t separate expenses into cost of goods sold, operating expenses, and non-operating expenses. In this case, you can still get a sense of how much it costs to run your business. Simply review your general ledger or expense report and identify any recurring costs that aren’t the direct labor and raw materials that go into producing a product.
Then add up those expenses to calculate your business’ operating expenses. Once you run the numbers, consider whether you can reduce operating costs to improve your bottom line.
Here are a few ways to cut operating costs:
- Look into renting a less costly location or working out of a home office to reduce rent and utility costs
- Shop around for lower insurance rates
- Take advantage when vendors offer discounts for paying invoices early
- Cancel unused subscriptions
- Consider outsourcing or automating admin tasks, such as bookkeeping, payroll, and human resources
- Try video conferencing as a cheaper alternative to traveling for meetings