Operating expenses (OpEx): Definition, calculation & tips

How much money do you need to keep your company up and running? And how can you more effectively manage finances?

In this guide, we’ll discuss operating expenses: how to calculate them, the different types of operational costs, and why they are essential for your business.  

What are operating expenses?

Operating expenses, or OpEx, are regular day-to-day operational costs of a business. They’re also indirect costs, as they’re not directly tied to the production of goods or service delivery. Still, they are essential for a business’s proper functioning. 

The scope of operating expenses depends on the industry, business type, and size. However, they are typically grouped into two categories: property-related and administrative expenses. 

Standard property-related expenses are:

• Rent
• Utilities
• Building reparations and maintenance
• Office supplies

Administrative expenses are:

• Salaries
• Insurance 
• Marketing 
• Research and development 
• Travel expenses

Fixed and variable costs

We can also classify operating expenses into fixed or variable.

Fixed operating expenses remain constant regardless of a company's productivity. For instance, rent and administrative salaries are fixed costs.  

On the other hand, variable costs change depending on your operations. Suppose you get more purchase orders this month than last. In that case, you'll incur higher transportation costs to deliver your product to buyers this month than you did the month before (i.e., transportation and fuel costs are considered variable expenses). 

Types of operating expenses

Regardless of the size and industry, most companies manage these operating expenses: 

1. Rent

Rent is the cost of using a property or location not owned by a company, such as a storage facility, office, or factory. 

2. Office supplies

These are items that are regularly used in the office and need frequent replenishment, such as sale and invoice receipts, staplers, pens, and printer paper.

3. Advertising

These are the expenses associated with any marketing activity: digital marketing campaigns, website, social media, business cards, and print marketing campaigns.

4. Salaries and wages

Administrative expenses from paying employees wages, payroll taxes, or benefits also account for OpEx.

5. Insurance

As an operating expense, insurance covers risks a company and its team may be exposed to, including employee injuries, property damages, or liability claims. Companies purchase insurance to protect their workforce and assets and ensure compliance with legal requirements, minimizing potential financial losses that could impact their operations.

6. Legal fees

Companies also incur operating expenses for regular legal services, such as regulatory compliance, dispute resolutions, intellectual property protection, and contract drafting.

7. Building maintenance 

This includes the costs associated with all unavoidable repair and maintenance tasks, such as repairing broken equipment to ensure the business's uninterrupted functioning.  

8. Inventory

Costs incurred for storing, handling, insuring, and managing inventory also fall into operating expenses. 

9. Travel

When a company reimburses employees for all travel-related expenses, the incurred costs are part of OpEx.

10. Depreciation

Depreciation refers to the costs incurred due to the decreased value of fixed assets. Computers, furniture, delivery vehicles, and more tend to depreciate in value over time, creating operating expenses.

Operating vs. Non-operating expenses

Operating expenses are costs companies incur as part of their regular, day-to-day business activities. Although these may not be directly tied to the production or delivery of products or services, they are essential for a company's core operations.

Non-operating expenses result from secondary activities of external factors and are not directly related to the business's primary operations. The most common examples of non-operating costs are:

• Exchange losses occur when a company is involved in international transactions with exchange rate fluctuations that lead to losses. For instance, if a company has sold its product to a country where currency was devalued before the payment was received, it may face exchange losses.
• Interest expenses are costs from borrowing money and paying interest on loans or credit. Interest expenses are considered non-operating because they are not incurred through business operations but are meant for financing the business. 

OpEx vs. CapEx 

OpEx (operating expenses) result from purchasing, maintaining, or upgrading tangible assets. CapEx (capital expenditures), on the other hand, are costs companies incur when making an investment. CapEx is usually tied to intangible assets such as:

• Intellectual property refers to legally protected creations of the mind, giving companies exclusive rights to their use.
• Copyright expenses occur when a company wants to secure and maintain legal protection for original work.
• Expenses on patterns occur when an individual or an organization applies for patents, which grant them the exclusive right to their inventions.
• Trademark costs result from registering and protecting a brand name, logo, or symbols that distinguish a business from competitors.  

Another difference between OpEx and CapEx is that companies are generally allowed to write off operating expenses at the end of the year, as long as it can prove those costs were ordinary and necessary. CapEx cannot be written off.

The importance of operating expenses

Effective management of operating expenses can lead to: 

Enhanced profitability 

Managing operating expenses can improve overall business profitability. By optimizing operating costs such as rent, utilities, or salaries, a company can reallocate resources more effectively, creating opportunities for new investment—primarily in innovation—leading to increased revenue and overall growth. 

Cost control

Cost control is critical for maintaining financial health. Companies should regularly review their spending to make adequate adjustments and allocate resources more effectively. Effective cost management ensures operations’ sustainability even during slow revenue growth or economic downturns. 

Increased investor confidence

Companies that control their operating expenses are seen as more stable and reliable and, thus, more attractive to investors. Effective expense management demonstrates discipline and responsibility, boosting investor confidence and attracting more capital. 

How to calculate operating expenses: 2 methods

Calculating operating expenses starts with gathering and categorizing all your business expenses. That means listing operating and non-operating expenses separately and dividing fixed and variable costs. Track expenses regularly so that at the end of the accounting period, you only need to extract operating expenditures. 

To calculate operating expenses, you can use these two methods/formulas:

Sum up all the business's operating expenses: 

Operating Expenses = Rent + Utilities + Insurance + Administrative Costs + Etc.

or

Subtract operating income and Cost of Goods Sold from total revenue: 

Operating Expenses = Revenue – Operating Income – Cost of Goods Sold.

The Cost of Goods Sold (COGS) is the costs incurred while producing your products or services, including labor costs and raw materials. 

2 Examples of operating expenses calculation

In practice, calculating operating expenses would look like this:

If we were to use the first operating expenses method, this would be the result:

• Rent - $1,000
• Utilities - $350
• Administrative costs - $6,000 

$7,350 (Operating expenses) = $1,000 (Rent) + $350 (Utilities) + $6,000 (Administrative costs)

If we were to use the second method and subtract operating income and Costs of Goods Sold from total revenue

• Revenue - $10,000
• Operating income - $1,700
• Cost of Goods Sold (COGS) - $3,500

$4,800 (Operating expenses) = $10,000 (Revenue) - $1,700 (Operating income) - $3,500 (Cost of Goods Sold)

When using the second method, also known as the indirect method, companies aim to calculate operating income (Net profit) by subtracting Costs of Goods sold (COGS) from the revenue to get the gross profit and, from it, subtract the expense costs to calculate operating income (Net profit):

Gross profit = Revenue - Cost of Goods Sold → Operating income (Net profit) = Gross profit - Operating expenses

Are operating expenses tax-deductible?

Operating expenses are generally tax-deductible under US laws. According to the IRS, companies can write off ordinary yet necessary expenses at the end of the year during which the costs were incurred.

To be qualified as tax-deductible, operating expenses must be ordinary (common and accepted in your industry) and necessary (helpful and appropriate for your trade or business). Costs not directly tied to your regular business operations, like non-operating expenditures, are not deductible. 

Deducting operating expenses lowers a company’s taxable income, reducing the amount of tax it must pay. As a result, companies have more financial means to invest in business growth. Deducting operating costs helps businesses better manage their finances while complying with tax regulations.

How to cut operating costs: 2 tips

We’ve already discussed the benefits of managing operating expenses, including better financial health and more effective allocation of resources. Here’s how you can cut operating costs and keep them aligned with your business needs.

Outsource non-core tasks

Outsourcing non-core tasks is an effective way to cut operating costs. Companies should consider collaborating with external service providers on essential yet not central operational tasks, such as administrative work or customer support. Outsourcing helps companies reduce labor costs while increasing hiring flexibility based on demand and access to expertise. That way, companies can better allocate resources while controlling their operating expenses. 

Improve inventory management

Companies can improve inventory management by using inventory management software. Technology can help you keep track of your inventory, make better purchasing decisions, prevent waste, and stay within budget.

4 best practices to manage operating expenses 

Review these suggestions to determine best-suited practices for your business. 

Calculate the operating profit margin 

Calculating the operating profit margin is essential for understanding how a business manages its operating costs in relation to total revenue. To determine the operating profit margin, divide the operating income by total revenue and multiply by 100 to present it as a percentage. This percentage demonstrates the portion of revenue that stays after all operating expenses are covered. Regularly calculating this margin enables companies to make better-informed financial decisions and improve profitability.

Track all your expenses

Organized record-keeping is essential for effectively managing operating expenses. Tracking expenses helps businesses detect spending patterns and stay within a budget. It also reveals saving opportunities, allowing more effective resource allocation across the organization.  

Define an expense policy

A well-structured expense policy provides guidelines for effective spending. It outlines what qualifies as a legitimate expense, the approval process, spending recommendations, best practices, and spending limits. Expense policies ensure consistency in controlling operating costs. 

Automate expense record and classification

Technological advancements minimize or eliminate the need for manual work, reducing human error while saving time and increasing accuracy. Automating expense recording and management allows companies to gain better insight into their spending patterns and understand where corrections are needed to prevent overspending.  

Easy expense tracking and reporting with Rippling

Rippling consolidates all of your company’s finances—from payroll and benefits to corporate cards and expense management–giving you an up-to-date view of cash flow across your company and offering unprecedented control over spending patterns.  

With Rippling you can: 

• Automatically route expenses and bills to the right approver every time. 
• Flag out-of-policy spending with hyper-custom policies, like by vendor or value, for further review. 
• Close the books faster with AI-powered transaction categorization, and integration with your accounting systems.

While most expense management solutions only allow for basic employee-manager approval chains, with Rippling expense management’s advanced policy engine, you can set hyper-custom policies based on the vendor, dollar amount, and expense category, helping you block out-of-policy expenses with ease. 

Operating expenses FAQs

Can operating expenses be reduced without hurting business performance?

Yes, companies can reduce operating expenses without hurting business. Strategies such as outsourcing core-tasks or using automation to streamline expense management helps maintain or even improve productivity. 

What is the impact of rising operating expenses on a business?

Rising operating expenses can reduce profitability and disrupt business operations. Such increases often force companies to increase the prices of their products or services, negatively affecting customer satisfaction. 

How can I forecast future operating expenses?

To make accurate predictions, companies must monitor industry trends, analyze data, and consider market changes. Budgeting software is a good option as it streamlines financial planning while ensuring accuracy and efficiency.

This blog is based on information available to Rippling as of October 29, 2024.

Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.