Operating Expenses

Operating expenses refers to expenditures that a business incurs due to activities that aren’t directly related with the production of goods or services. Often abbreviated as OPEX, operating expenses include rent, equipment, inventory costs, marketing, payroll, insurance, step costs, and funds allocated for research and development.

Understanding Operating Expense

Operating expenses are necessary for many companies and unavoidable. While some businesses focus on reducing operating expenses to gain a competitive advantage and increase earnings, reducing operating expenses can also compromise the integrity and quality of operations. There’s a delicate balance most are trying to find, one that is focused on quality and profit.

Now, the Internal Revenue Service (IRS) allows businesses to deduct operating expenses if the business is operating  to turn a profit. Even so, the IRS and most accounting principles distinguish between operating expenses and capital expenditures.

Let’s take a quick look at a few operating expenses and how each would be categorized below.

Compensation Related Operating Expenses

  • Compensation and related payroll tax expenses, only for non-production employees
  • Sales commissions (though this could be interpreted as a variable cost, placing it into cost of goods sold)
  • Benefits for non-production employees
  • Pension plan contributions, this would be for non-production employees

Office Related Operating Expenses

  • Accounting expenses
  • Legal fees
  • Office supplies
  • Utility costs
  • Insurance costs
  • Property taxes
  • Depreciation of fixed assets, only non-production areas
  • Repair costs for non-production facilities
  • Rent costs for non-production facilities
  • Sales and marketing-related operating expenses

Advertising And Marketing Costs

  • Direct mailing costs
  • Entertainment costs
  • Sales material costs (sales script, brochures, etc.)
  • Travel costs

Important: Finance-related costs may be excluded from the operating expenses definition, on the grounds that they are not generated by the ongoing operations of a business. If these costs were to be included, examples would include auditor fees, bank fees, debt placement costs, and interest expense.

The definition of operating expenses is sometimes expanded to include the cost of goods sold, thereby encompassing every operational aspect of a business. If so, the following costs are also examples of operating expenses:

  • Freight in & freight out
  • Direct materials
  • Direct labor
  • Benefits for production personnel
  • Utility costs for production facilities
  • Rent of production facilities
  • Property taxes on production facilities
  • Compensation for production personnel
  • Depreciation of production equipment and facilities
  • Repair of production equipment and facilities
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