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.
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.
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:
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.
Essentially, operating expenses are the costs of keeping the business running, beyond direct materials and labor. Examples of operating expenses include things like:
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:
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.
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.
Non-operating expenses are expenses a business incurs that aren't related to its core operations. Some examples of non-operating expenses include:
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.
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:
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