What Are Operating Expenses and How Are They Calculated?
Discover how identifying and calculating operating expenses provides a clear view into a company's daily financial health and operational performance.
Operating expenses represent the costs a business incurs for its normal operational activities that are not directly tied to producing goods or services. These ongoing costs are necessary to maintain the business, regardless of sales or production volume. Understanding these costs is part of assessing a company’s financial health and operational efficiency.
Common Types of Operating Expenses
Operating expenses are categorized as Selling, General, and Administrative (SG&A) costs on a company’s income statement. This grouping separates the day-to-day business running costs from the direct costs of creating a product. SG&A expenses represent the overhead required to support the entire business operation.
Selling expenses are costs incurred from the effort to market and sell products or services. This includes expenditures such as advertising campaigns, digital marketing, and promotional materials. It also covers the salaries and commissions paid to the sales staff, their travel and entertainment expenses, and product distribution costs like shipping and handling fees.
General and Administrative (G&A) expenses are the costs necessary to run the overall organization, rather than a specific department. Also known as company overhead, these costs include salaries for employees in human resources, accounting, and executive management. Other common G&A expenses include:
- Rent for office space
- Utilities and property taxes
- Business insurance
- Office supplies
- Professional fees for legal or accounting services
Expenses Not Classified as Operating Expenses
To understand operating expenses, it is useful to know what they are not. Certain business costs are accounted for separately because they are not related to the principal revenue-producing activities of the business.
A primary example is the Cost of Goods Sold (COGS), which includes the direct costs of producing goods. This encompasses raw materials and the direct labor for workers who make the products. The distinction is that COGS is tied directly to manufacturing, while operating expenses are the indirect costs of supporting the business.
Capital Expenditures (CapEx) are also separate from operating expenses. CapEx involves funds used to acquire, upgrade, and maintain physical assets like property or equipment. Unlike operating expenses, which are deducted when incurred, CapEx represents long-term investments. The cost is spread out over an asset’s useful life through depreciation.
Non-operating expenses are costs unrelated to a company’s core business activities. This category includes interest expense from borrowing money and losses from the sale of assets or investments. These items are listed separately on the income statement from operating expenses.
Calculating and Analyzing Operating Expenses
Total operating expenses are listed on a company’s income statement. On this statement, Cost of Goods Sold is subtracted from revenue to find gross profit. Operating expenses are then subtracted from the gross profit.
This calculation determines the operating income. The formula is: Revenue – Cost of Goods Sold – Operating Expenses = Operating Income. This figure reveals how much profit a company generates from its core business operations, before interest and taxes, and measures the profitability of its primary activities.
Another analysis tool is the Operating Expense Ratio (OER). This is calculated by dividing total operating expenses by total revenue (OER = Operating Expenses / Revenue). The resulting percentage shows how much of each revenue dollar is used for operating costs.
The OER measures a company’s operational efficiency. A lower ratio indicates effective cost management relative to revenue. Businesses track this ratio over time to identify spending trends and compare their efficiency against competitors.