As a business owner, you need to get to terms with how operating expenses are classified, how they work, and why they’re important for sound financial management.
Operating expenses (definition)
Operating expenses, or operating costs, are those regular and ongoing costs that your business pays the pursuit of creating revenue. Operating expenses are essential outgoings that are necessary to the day-to-day functioning of the business.
Operating expenses can include:
- rent
- salaries and wages
- utilities
- insurance
- depreciation
- maintenance or repairs
- marketing and advertising
- taxes.
Operating expenses and cost of goods sold (COGS)
Importantly, operating expenses incurred in regular day-to-day business are separate from ‘cost of goods sold’ (COGS), which expenses that are incurred in the direct production of goods or services.
What is an operating profit?
By deducting operating expenses from a business’s revenue, you can calculate its ‘operating profit’ or ‘operating income’.
Calculating your operating profit from your operating expenses is invaluable in determining your business’s profitability and ensuring continued financial health.
(Generally, a business should be seeking to control and optimise operating expenses and boost operating profit with solid cash flow to improve its overall financial performance and stability.)
Operating expenses vs. capital expenditures
While an operating expense is tied to regular business operation costs and operating income, capital expenditures (CapEx) refer to long-term expenses and investments.
Capital expenditures generally refer to the purchase, maintenance or upgrading of big-ticket items like:
- vehicles
- equipment
- machinery
- buildings
- land.
