What are Operating Expenses ?

Operating expenses are the costs incurred by a company to perform its operational activities. These expenses include – inventory cost, rent, marketing, insurance, payroll and research and development funds, among others and are considered mandatory for ensuring continuance and profitability of a firm’s operations.

Operating expenses may also be known as Selling, General, and Administrative (SG&A) expenses and in Accounting terms, the abbreviation OPEX (or OpEx) is widely used to refer to operating expenses. 

However, these expenses do not include cost of goods sold (materials, direct labor, manufacturing overhead) or capital expenditures (larger expenses such as buildings or machines) because COGS relates directly to a firm’s core production as opposed to its daily operations.

IMPORTANCE OF OPERATING EXPENSES

The following points highlight the importance of operating expenses for a firm –

  1. Operating expenses (OPEX) are an integral part of any business. These expenses are reflected mainly on the income statement and is one of the main components that determine operating income.
  2. They can help assess a company’s cost and stock management efficiency.
  3. These expenses also help to identify recurring expenses which are not essential for the business operations and allows business owners to make necessary adjustments.

OPERATING EXPENSES ON THE INCOME STATEMENT

Normally, operating expenses are recorded in the income statements to find out what is the operating income after taking them out from gross profits. The expenses a business incurs falls under any of these six main groups:

  • Selling, general and administrative costs
  • Costs of goods sold
  • Depreciation and amortization
  • Income taxes 
  • Interest expenses
  • Other operating expenses.

All these are considered to be operating expenses. But when determining operating income with the help of the income statement, income tax and interest expenses must be excluded.

CALCULATION OF OPERATING EXPENSES –

The best way to compute the OPEX of a firm is by identifying recurring costs other than the cost of direct labour or raw material required for the production process.  Subsequently, by adding the said expenses, one can easily ascertain the operating expenses of a firm in a given accounting period.

With the help of operating expenses , the operating expense ratio can also be calculated as –

          OER = (COGS + OPEX) / Revenues

It must be noted that high operating expenses indicate poor stock management by a firm . Therefore, companies must try to reduce their operating expenses by adopting cost-cutting techniques and lowering their everyday operational costs to improve their efficiency  .

Accounting & Finance for Banking

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