What Are Operating Costs and What Do They Include?
Learn how daily business expenses reveal core profitability and efficiency, distinct from the costs of production or long-term asset investments.
Operating costs represent the expenses a business incurs to perform its normal operational activities, keeping the company running daily. Understanding these costs provides a clear view of a company’s financial health and operational efficiency. This knowledge allows for better financial management, helping to identify areas where a business can trim expenses without negatively impacting its ability to generate revenue.
Components of Operating Costs
Operating costs are typically broken down into two main categories: Cost of Goods Sold (COGS) and Selling, General, & Administrative (SG&A) expenses.
COGS includes the direct costs tied to producing goods or services. This covers raw materials, the direct labor of production workers, and manufacturing overhead. For example, for a furniture maker, the cost of wood, screws, and the wages of the craftspeople who build the chairs are all part of COGS. These costs are directly traceable to the finished product.
SG&A expenses are the indirect costs required to run the business itself. These expenses are incurred regardless of the company’s production or sales volume. Common SG&A costs include:
- Rent for office space and associated utilities, such as electricity, water, and internet service.
- Salaries and wages for non-production employees, including management, the sales team, and administrative staff, along with related payroll taxes and employee benefits.
- Marketing and advertising expenditures, which can range from digital advertising campaigns and social media management to traditional print ads.
- Office supplies, such as paper and toner, along with the routine maintenance and repair of office equipment.
- Professional service fees for legal counsel or accounting, and insurance premiums for general liability, property, or workers’ compensation.
What Is Not an Operating Cost
A major exclusion from operating costs is Capital Expenditures (CapEx). CapEx refers to the funds a business uses to acquire, upgrade, and maintain its long-term physical assets, such as land, buildings, machinery, and vehicles. Unlike operating costs, which are expensed on the income statement as they are incurred, capital expenditures are treated differently.
When a company makes a capital expenditure, the purchase is recorded as an asset on the balance sheet. The cost of this asset is then gradually expensed over its useful life through a process called depreciation. This accounting treatment reflects that the asset will provide value to the company over several years. For instance, the purchase of a new delivery truck is a capital expenditure, while the fuel and maintenance for that truck are operating costs.
Locating and Calculating Operating Costs on Financial Statements
The income statement is the primary financial document for analyzing operating costs. On this statement, Cost of Goods Sold (COGS) is subtracted from total revenue to determine a company’s gross profit. The remaining operating costs, detailed as Selling, General, & Administrative (SG&A) expenses, are then subtracted from the gross profit.
To determine profitability from primary business activities, you can calculate operating income. The formula is: Operating Income = Gross Profit – Selling, General, & Administrative Expenses. This calculation isolates profit from core operational efficiency. While sometimes confused with Earnings Before Interest and Taxes (EBIT), operating income is a stricter measure because EBIT can include non-operating income.
The resulting operating income figure shows how much profit the business is generating from its main operations before accounting for financial and tax-related expenses. A strong operating income suggests the company’s core business model is sound and that it is effectively managing its daily operational costs.