Guide to Operating Expenses: Types, Examples & Calculation

Accounting for expenses is a critical part of every business, regardless of its scale. But things get complicated when as a business owner, you don't understand the core difference between the expenses. Managing a well-organized expense mechanism means your small business can operate seamlessly.

So what are these different expenses you must account for? For starters, every business owner must know what operating costs are. OPEX or operating expenses ensure a business completes its routine proceedings and also maintains adequate finances.

Understanding its fundamentals is pivotal, and we will help you achieve that. Here is everything every small business owner must know about operating expenses and small business tax deductions.

What are Operating Expenses?

Operating expenses can be defined as the cost incurred by a company without producing a product. Any expense that's used to keep your business functioning is an operating expense. These expenses can vary depending on your industry, but some remain constant across every sector. Expenses like marketing, insurance, inventory, rent, R&D, and payroll are the most common ones.

OPEX plays a direct role in calculating a business’ net income. As a small business owner, you deduct your business' COGS (Cost of Goods Sold) from its revenue to get its gross profit. In the next step, you deduct the operating expenses to get your operating income.

Finally, after adding/subtracting the total non-operating income/expenses, you get your net income. The more operating expenses your business incurs, the less cash it will have. As a result, every small business must moderate its operating expenses to maintain a healthy financial portfolio.

How Can You Calculate Operating Expenses?

While the expenses differ for every business type, you can find operating expenses in your business’ income statement. As a business owner, you merely need to check the general ledger and look for expenses that do not directly affect your development costs.

Since operating expenses dictate how much funds the business has, it is essential to calculate them thoroughly. As there is no universal operating expenses formula, the best way to do it is by locating concurring expenses other than raw material and labor costs. Adding these will uncover your operating expenses.

Doing so also allows you to calculate the OER (operating expense ratio). While you can assess your operating efficiency through OPEX alone, an OER will help you draw a comparison against your competitors.

The operating expense ratio formula is:

(Cost of Goods Sold + Operating Expenses) / Revenues = Operating Expense Ratio

Look at the example below to get a better understanding of the concept:

As per the given figures, the OER (operating expense ratio) will be:

Operating Expense Ratio = (Cost of Goods Sold + Operating Expenses) / Revenues

= (16,730,000+11,529,000) / 35,238,000

= 28259000/35238000

= 0.8

As you can see, the business is spending 80 cents for every dollar earned on routine expenses. Whether the figure is productive or not depends entirely on your industry's norms. As a result, the next step after calculating operating expenses should be a quick comparison.

Review the average OER on the market and how much your direct competitors are spending on a day-to-day basis. Set adequate benchmarks for your business and keep an eye on them. A surging operating expense ratio means your business’ operating efficiency is declining.

The higher your OER gets, the lower your operating efficiency is. Thus, business owners can get a clear idea of their finances and efficiency through the ratio alone.

What Are Some Examples of Operating Expenses?

As stated already, operating expenses depend majorly on your industry's nature and business setup. However, here are some common operating expenses most businesses incur:

• Licensing
• Payroll
• Insurance
• Sales Commission
• Repairs and Maintenance
• Legal Fee
• Marketing
• Advertising
• Utilities
• Property Tax
• Accounting Expenses
• Office Supplies
• Travel
• Motor Charges

Why are Operating Expenses Important?

Before understanding how maintaining operating expenses can help your business, let's understand their importance.

• OPEX helps figure out recurring expenses that aren’t essential for the firm to operate. This allows business owners to make any necessary adjustments and minimize unnecessary costs.
• With operating expenses, you can assess your stock and cost management efficiency as well. While earning revenue is crucial, it will not make a difference if you are spending it all just to keep functioning.
• You can undertake (link: https://fincent.com/glossary/horizontal-analysis text: horizontal analysis) to evaluate their business’ precise market standing with operating expenses.
• simple guide: what is chart of accounts

As a small business owner, you can try different steps to reduce your operating expenses. Some of these include:

• Try altering your product price model to improve your business’ liquidity and revenue. Finding the perfect pricing can take time but offers improved results.
• Using cheaper raw materials or labor to reduce the Cost of Goods Sold is also a viable idea. However, try to maintain a decent product quality since it directly affects your business' sales.

If both ideas do not bode well with your business model, try:

• Reducing utility and rent expenses by shifting to a cheaper location or working remotely.
• Paying off invoices early to avail of discounts from vendors.
• Automating or outsourcing activities like human resources, payroll, and bookkeeping.
• Getting rid of unused subscriptions.
• Opting for video conferencing instead of traveling for every business meeting.
• Searching the market for lower insurance rates.

Calculating your operating expenses and maintaining them means your business can benefit from optimal liquidity. As a result, it can improve your business operations without compromising your products' quality.

What are Non-Operating Expenses?

As the name suggests, non-operating expenses are costs incurred by the business that do not serve the core activities. In other words, any expense that is not mandatory for business operations is a non-operating expense. Similar to OPEX, non-operating expenses differ for businesses across various sectors.

Some of the common non-operating expenses include:

• Legal expenses
• Losses from derivative instruments
• Depreciation
• Lawsuit settlement expenses
• Losses due to exchange fluctuations
• Restructuring costs
• Amortization
• Interest
• Obsolete inventory charges
• Impairment loss
• Losses from asset sales
• Bad Debt Expense

Since non-operating expenses are not essential for your business' core operations, you should identify them. Noting down their infrequency can also help you improve the results of your operations.

Closing Thoughts

Running a small business can be a handful as you can try a million things to achieve stability and liquidity. But the simplest and the most common method you can try is categorizing and moderating your expenses. That is why small businesses try to find the optimal amount they should spend on their operating expenses.

However, given the importance of operating expenses in a business's core operations, finding the right balance is tough. This article has mentioned some key information regarding the topic that may help you out.

If you feel like these financial responsibilities are keeping you from scaling your business, you can partner with industry-leading bookkeeping services like Fincent, who can take these operations off your plate.  

This way, you can ensure your business always has optimal cash and functions at its most efficient at all times.