A Quick Guide to Operating Expenses

operating expenses

What is an Operating Expense?

Often abbreviated as OPEX, Operating expenses include rent, equipment, inventory costs, marketing, payroll, and funds for R&D. In other words, these are any expenses a company incurs through its normal business operations.

Operating expenses include:

  • Payroll for staff (excluding labor for manufacturing)
  • Insurance
  • License fees
  • Rent
  • Research
  • Marketing (including for social channels like Facebook)
  • Accounting fees
  • Building maintenance and repairs
  • Office supplies
  • Utilities
  • Attorney fees
  • Property taxes on real estate
  • Vehicle expenses
  • Travel expenses

Operating Expense vs. Non-operating Expense

A non-operating expense is an expense incurred by a business that is unrelated to its core operations. For example, the most common types of non-operating expenses are depreciation, amortization, interest charges, or other costs of borrowing.

Operating Expenses vs Capital Expenditures

The counterpart of operating expense is a capital expenditure (CAPEX). This includes costs related to acquiring or upgrading tangible and intangible assets. For example, purchasing machinery is considered a capital expenditure. On the contrary, repair and maintenance of the machinery are considered an operating expense.

The IRS treats the capital expense differently than the operating expense. According to the IRS, operating expenses must be ordinary which means common and accepted in the business trade. Besides, they have to necessary which means helpful and appropriate in the business trade. In general, businesses are allowed to write off operating expenses for the year in which the expenses were incurred. Otherwise, businesses must capitalize on capital expenses/costs.

Increase or Decrease in Operating Expenses

An increase in operating expenses means less profit for a business. A company may try to reduce operating expenses by outsourcing areas of the business. Otherwise, they can allow some of the existing staff to work from home. This cuts down on the actual physical space needed for staff at the office. In addition, management may also try implementing money saving techniques. For example, automating parts of the business or reducing salaries for new hires.

Fixed Costs and Variable Costs

When it comes to analyzing the operating expense, classify it as either fixed cost or variable cost. This way, a manager can better understand the nature of the expense.

Fixed cost is the cost that remains the same in the short-term and can only change in the long term. Meanwhile, the variable cost depends on the company’s operational decisions. For example, expenses such as rent and employee wages are fixed costs, while purchased supplies are variable costs.

Understanding the distinction can help managers to better control the operating expenses while considering the timeframe.

Conclusion

  • Operating expense reflects the operational activities, not the investing or financing activities of a company.
  • Operational activities are a company’s key commercial activities in generating revenue.
  • When it comes to physical assets, it is vital to distinguish between an operating expense and a capital expenditure.

Learn easy techniques to improve your Financial Modeling skills and make your profile outstanding. keySkillset is here to help.

Free Educational Games

MS Excel | PowerPoint | Financial Modeling


 

or

Share on facebook
Share on twitter
Share on linkedin