What are Operating Expenses: Management and Calculation
All businesses, big or small, have operating expenses that need to be tracked. It refers to the expenses that a company must incur in order to run its business particularly for the purpose of producing revenue.
Understand the primary drivers of business costs to properly identify areas that need to be managed immediately.
Operating expenses can impact your profit growth, so keep an eye on it.
What are Operating Expenses?
Operating expenses or operational expenditures (OPEX) are essentially the expenses your business would incur regardless of whether your business is operating or not. It’s a term used by a lot of companies, a small business like a small pet store or a large corporation such as a bank has OPEX.
An increase in OPEX will affect a company’s ability to make it profitable. There are ways businesses can try to reduce their OPEX such as allowing their staff to work from home to save on office rent and utilities.
Automation and outsourcing are also key to a bulk reduction in OPEX in employee wages and benefits.
But in reducing your OPEX, there are risk factors to consider too. Reducing these expenses can compromise the quality of your product or service. So there should be a good balance between cost reduction and quality assurance.
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What is Included in Operating Expenses?
As your business runs, you will incur OPEX. These expenses are those that are not for the sole purpose of making the company profitable. OPEX are, in other words, costs that cannot be put off.
These expenses include:
To summarize, OPEX are the costs that continue to exist for a company even when it’s not making a profit. These costs are related to day-to-day operations. In most cases, these expenses are variable, meaning that they change depending on the volume of business.
What are Non Operating Expenses?
The non operating expenses are expenses that do not directly result in an increase in the profit of the business. The majority of these expenses relate to financing and fees.
These non operating expenses are:
These types of expenses fall into the regular business expenses and can be seen as a cost of doing business.
Fixed Costs and Variable Costs Expenses
OPEX can be broken down into two general categories: fixed and variable operating expenses.
Fixed expenses are those that do not vary based on how much business you are doing.
For example, your rent is fixed because it will always be the same amount, regardless of how much business you do. These types of expenses are sometimes called overhead expenses.
Variable expenses are those that change based on how much business you are doing.
For example, if you hire additional staff to help out, you need to pay their wages whether your business is doing great or not. If your travel expenses increase because of additional work needed, then that would count as one of your variable expenses too.
What are Overhead Expenses?
Overhead costs are ongoing expenses needed for a business to run. They are necessary business expenses that are not directly related to the production or sale of the goods or services.
A lot of overhead expenses are fixed, which means that they will stay the same from one month to the next – like rent and permits. Other overhead expenses, such as insurance, may vary each month.
How to Calculate Operating Expenses
The first step to calculating your OPEX is to list down your operational activities and their costs.
Here’s the operating expenses formula:
Operating Expenses = Rent + Utilities + Marketing + Permits + Labor + Depreciation + Other operating expenses
Here’s a table for operating expenses examples:
|Operational Activity||Operating Expenses|
|Rent and Utilities||$25,000|
|Marketing and Advertisements||$55,000|
|Licenses and Permits||$20,000|
In this table, the total OPEX is $200,000.
Calculate Operating Expenses Ratio
To find out your operating expenses ratio (OER), use this formula:
OER = (OPEX + COGS) / Gross Revenue
|Cost of Goods Sold||$250,000|
|Total Operating Expenses||$150,000|
Using the formula and table above, we will arrive at this calculation:
OER = 150,000 + 250,000 / 450,000
OER = 0.88
In this sample calculation, the OPEX ratio is 0.88. Meaning, a business spends $0.88 for every $1 they earn. Is this high? That depends on the type of business and their market standards.
To understand whether your business operating expenses are on the higher or lower end, it’s good practice to check the average industry benchmark. This gives you a better understanding of whether you should cut costs or there is still room for expenses that will help your profitability.
How to Reduce Operating Expenses
If you are a small or a startup business, you may have to keep your expenses down to a bare minimum. Take a look at your finances and see where you can cut back.
In the event that the company is not able to sell its products or services to cover its operating costs, the company must borrow money to continue operations.
Reducing your operational cost will depend on the type of business you run. To give you an idea, here are some ways to keep your operating expenses at a minimum.
- Find a new supplier that has a better price or better delivery time.
- Reduce transportation costs by having a supplier closer to you.
- Add more automation into your production process to reduce labor costs
- Cut back on consultants or professional services
- Reduce the number of office locations
- Outsource labor from other countries
Cutting costs ensures that you have the money you need to put into growing your business. Lower operating costs will help you stay competitive in the market as you can pass on your savings in this area to your consumers by offering lower prices. This can also translate into your marketing activities and attract more customers.
More Examples of Operating Expenses
Each business type has different operational costs. If you’re looking for an idea of what they are depending on the industry, we’ve listed them below.
Note that these are samples of how each industry has differentiating operational costs. It can vary per business too.
Some companies heavily outsource, thus, some of their OPEX will be under one category. That is if they have multiple outsourced services from a single provider.
However, that will also highly depend on how a business tracks its list of operating expenses.
Managing Operating Expenses
The size of your business won’t matter – OPEX will always be part of running a business. So managing and making it efficient should be a top priority.
Operating expenses are usually the first to be slashed in case a business is spending more than its earnings.
Tracking your operating expenses as detailed as possible ensures that your costs and stocks are met efficiently. It significantly helps how your business generates its revenue and keeps the goal of the company in mind.