If you run your own business, you might be aware of business expenditures that are unavoidable as long as your business is operational. Similarly, operating expenses are one such category of expenses that are necessary to ensure your business runs smoothly.
Recording these operating expenses not only helps you gauge the business’s financial success but also ensures compliance with local tax laws and regulations. Therefore, you must understand how to calculate operating expenses to keep your business running efficiently and stay tax-compliant.
Especially if you are coming up with a new business, understanding operating expenses becomes important. That’s what we will discuss in this blog. We will throw light on operating expenses definition, how to calculate it, and examples of operating expenses.
What are Operating Expenses?
Commonly known as opex, operating expenses are the costs incurred due to business operations. These are necessary expenditures that allow your business to run its day-to-day operations smoothly. Office rent, utility bills, travel costs, material costs, and staff salaries fall under operating expenses.
Operating expenses can be linked directly to the business operations (direct expense) or may not be associated directly (indirect cost). So, any cost that a business incurs through its core operations will be operating expenses. Let us understand what is operating expenses by taking real-life examples of operating expenses.
Operating Expenses Example
Let’s say you run a bakery that generates revenue by selling cake, eggs, bread, and cookies. For making them, you bring flour, sugar, and other ingredients that are essential for baked items. So, the cost of ingredients, wages paid to the bakers, and utility bills for ovens fall under operating expenses (direct expenses).
Other costs that are not directly linked to the production process such as marketing costs and bakery rent are indirect operational expenses. Thus, all necessary expenditures required to run your bakery are operating expenses.
What Is Included in Operating Expenses?
Operating expenses cover the direct or indirect costs that are related to your core activities. These expenditures may vary according to your business type and industry. Let’s check out some common operating expenses.
Staff payroll – Your employee salaries are operating expenses as workers are compensated for their time and effort.
Insurance – Various types of insurance, such as health, liability, or property insurance, to protect against unexpected risks and financial losses are operating expenses.
License fees – Required licenses and permits to operate your business legally and comply with regulations are also operating expenses.
Shop rent – Rent for office space you pay regularly to keep the space for operations also included as operating expenses.
Marketing cost – Promoting products or services involves expenses such as advertisements, digital marketing, and promotional materials to attract and retain customers.
Building maintenance – Maintenance collected to keep the workplace in good condition and a safe working environment comes under the operating expenses category.
Office supplies – The cost of essentials or materials required for smooth business operations is part of operating expenses.
Utility bills – Bills you pay for electricity, water, or internet services for running a business activities are included in operating expenses.
Property taxes – Property tax you pay to the local authorities in order to comply with tax laws falls under operating expenses.
Travel expenses – Travel expenses such as accommodation, airfare, and meals when traveling for work-related activities are operating expenses.
How to Calculate Operating Expenses
Prior to understanding how to calculate operating expenses, make sure you can track expenses using automation tools, or manually. This is because if you manage expenses well, you can easily break them down and determine whether there is a change in fixed or variable expenses. The operating expenses formula is simple, but make sure you start calculating the process once the accounting period is completed.
In this process, you need to gather the accurate direct expenses, indirect expenses, and the total revenue generated during the specific period. Remember you don’t need non-operating expenses, so exclude business loan payments, taxes, or investments. Once you have all the details ready, populate the below formula to assess business profitability and find areas where you can cut costs.
Operating Expenses Formula
You can utilize two formulas for determining operating expenses. Either you can add all operating costs at once or you can take off operating costs and cost of goods sold (COGS) from the revenue.
Operating Expenses Formula:
Office space rent + utility bills + business insurance + other production cost = Operating Expenses
Or else, to find operating expenses, you can subtract the operating income and COGS from the total revenue earned.
Total revenue – operating income – cost of goods sold = Operating Expenses
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Types of Operating Expenses
Operating expenses consist of different categories that are important to drive business, leading to desired profit growth.
1. General Expenses
General expenses are unavoidable costs required to keep a business running smoothly. Rent or lease payments for office space, and other utilities such as electricity, phone, and internet, including office supplies fall under this category. Therefore, businesses need to analyze these costs if they want to optimize their budget plan.
2. Depreciation & Amortization
These expenses are related to tangible and intangible assets like heavy equipment, and vehicles. Depreciation includes the wear and tear of tangible assets, whereas amortization involves intangible assets. Tracking such expenses will help you wisely allocate funds for business assets rather than spending large amounts upfront.
3. Cost of Sold Goods (COGS)
This type of operating expenses is tied directly to your production process, allowing you to manufacture goods and services in a timely manner. It mainly comprises raw materials, direct labor, packaging, and manufacturing overhead. For service-based businesses, it includes direct labor costs and other expenses incurred to provide the service.
4. Product or Service Marketing Cost
Marketing costs incurred in a bid to promote your products or services are essential for customer acquisition, and brand awareness. Promotional campaigns you run to lure the target audience collectively contribute to the operating expenses. The cost of business website promotion, offline ads, or online marketing falls under this category.
How to Manage Operating Expenses
Since operating expenses give a clear picture of expenditures required to run your daily operations, managing them is important. Let us find out how to organize your expenses.
1. Get Expense Management Software
Prioritize using expense management software to track and categorize business expenses quickly instead of doing it manually. The software automates calculations, minimizes errors, and gives in-depth insights to help you stay on top of your business’s financial health without your time and effort.
2. Track Expenses Regularly
The process of tracking operating expenses is easier when you have expense management software like Moon Invoice. No need for manual entries, you can easily maintain accurate expense records without doing paperwork. It further simplifies the expense tracking process by allowing you to generate high-quality expense reports.
3. Review & Manage
Review expense reports to spot wrong spending and optimize your budget plan accordingly. You can even compare expenses with the net revenue. This will ensure you run a profitable business and seize cost-saving opportunities. That’s how you can manage expenses without buying more time and concentrate on other activities.
Operating vs. Non-Operating Expenses
Here’s how operating expenses are different from non-operating expenses. Take a look.
| Differences | Operating Expenses | Non-operating Expenses |
|---|---|---|
| Meaning | They are directly related to the core business operations and day-to-day running activities, which are essential for generating revenue. | They arise from activities not linked to the core business functions. Non-operating expenses can often be irregular or one-time expenses. |
| Purpose | They ensure smooth business operations like electricity, salaries for employees, and equipment maintenance. | They deal with your financial obligations like investments, or extraordinary events that don’t contribute directly to the revenue-producing activities. |
| Financial Reporting | They are included under the section for operating expenses mentioned in your income statement to maintain transparency. | They need to be shown separately below operating profit to distinguish them from daily business operations. |
| Examples | Operating expenses examples are office rent, utility bills, employee salaries, office supplies, costs for marketing and advertising purposes, insurance premiums, and maintenance fees. | Loan payments, yearly taxes, dividends paid to shareholders, foreign exchange losses, depreciation and amortization are all non-operating expenses. |
Importance of Operating Expenses
Operating expenses can help you drive a profitable business, ensuring you spend only what is actually required rather than overspending business expenses. Here are a few reasons why operating expenses matter for every business.
1. Identifying Financial Health
Determining a business’s financial well-being is important and that’s what operating expenses represent. They not only show you a bigger picture of your company’s financial health but also aid in scaling business profitability. If you discover operating expenses are high, there might be inefficiencies in business productivity.
2. Setting Up Optimized Budget
Managing operating expenses can help you find wasteful spending and make sure funds are allocated correctly, allowing you to prepare an optimized budget for the next year. Organizing operating expenses well also aids in using financial resources wisely, helping you enhance the cash flow management.
3. Complying With Tax Laws
Apart from economic benefits, operating expenses must be tracked and managed well in order to comply with local tax regulations. Everything utility bills, insurance or other supplies costs should be identified separately and added to the income statement. Thus, keeping well-documented records can ease the audit process and ensure adherence to tax regulations.
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Conclusion
In conclusion, operating expenses are an irrefutable cost as long as you want to keep your business operations up and running. What’s important is you should keep them well organized and calculate them periodically to accomplish profit goals and eradicate overspending. Managing operating expenses regularly can also ensure you stay tax-compliant.
All you need is ideal expense management software like Moon Invoice to handle the expense tracking process and allow you to focus on important business activities. It is cloud-enabled software that not only stores unlimited expense reports but also provides easy accessibility. Utilize a free trial to know how it works and achieve your business goals in less time.
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Jayanti Katariya is the founder & CEO of Moon Invoice, with over a decade of experience in developing SaaS products and the fintech industry. He holds a degree in engineering. Since 2011, Jayanti's expertise has helped thousands of businesses, from small startups to large enterprises, streamline invoicing, estimation, and accounting operations. His vision is to deliver top-tier financial solutions globally, ensuring efficient financial management for all business owners.
