What Are Operating Expenses?

There’s no end to the different strings a business owner must have to their bow. As well as staff management and business strategy, you also need a good grounding in accountancy. Or at the very least, general finance. That’s so you can avoid falling foul of tax rules or accruing unnecessary debts.

The first step to robust financial management is understanding the area’s lexicon. After all, many different terms and phrases can be tough to get your head around. One such is the term ‘operating expense’.

What is an operating expense? What other types of expenses are there, and how do they differ? How can you best manage your operating costs? These are all the things you’ll learn by reading on. 

Defining Operating Expenses

An operating expense is an expense you incur through your regular business operations. They’re the costs you face merely for doing what you have to do day-to-day to trade. As such, what counts as an operating expense differs from one firm to the next.

For example, say you run a contact center. In that case, the cost of RingCentral call center software will count as an operating expense. If you operate an ecommerce site, meanwhile, web hosting costs would be operating expenses.

The following are all typical, easy to understand examples of operating expenses:

• Rent & business rates.

• Payroll.

• Inventory costs.

• Essential equipment.

• Business insurance.

• Employee benefits.

• Pension contributions.

• Advertising & marketing expenses.  

Understanding Operating Expenses

You can’t run a business without incurring operating expenses. Some will encounter more than others due to the nature of their industry. For instance, you may work in a niche with high standards of safety that must get met. This is particularly apt in the time of Covid-19. In that case, what you must spend to get compliant counts as operating expenses.

It’s crucial to understand operating expenses as how you deal with them differs. That’s in terms of tax and accountancy, and as compared to other costs. The two most notable different kinds of expenses are capital and non-operating expenses. So, let’s directly compare these to the operating alternative.  

1. Vs. capital expenses. 

Capital expenses are costs firms incur while making an investment. For instance, they may upgrade some equipment or acquire a patent for new VoIP technology. These are expenses businesses choose to take on in the hope of getting a return on investment down the road. Research and development is another typical capital expense.  

Operating expenses, meanwhile, are ordinary costs that have to get paid for a firm to trade. That’s an important distinction and is one of which the IRS takes note. Operating expenses can get written off for the year in which they’re incurred. Capital expenses must get capitalized or written off over a more extended period. 

2. Vs. non-operating expenses.

Non-operating expenses are a whole different category. These are costs defined as unrelated to a company’s central operations. As such, many firms won’t incur many of this type of expense. The two most common examples of non-operating costs are depreciation and amortization. 

Depreciation is an accounting process whereby a firm writes off the value of an asset over time. Substantially, as recognition of the fact that the asset’s value reduces. Amortization is a technique that similarly lowers the value of a loan or intangible asset. 

Managing Operating Expenses

Understanding and managing your operating expenses is critical. These costs must get covered, or you won’t be able to survive day-to-day. However, you may choose to try and save money by limiting the expenses where possible. 

Doing so can be a savvy and successful tactic. Reduce your operating expenses while maintaining turnover, and your profit margin will improve. You always have to consider the impact cutting these costs may have, though. 

Make trims in the wrong areas, and your business may suffer. Say, for instance, you reduce your customer service budget. That could make it more difficult for callers to reach an agent. As a result, your customer retention rate may suffer. You’ll lose loyal customers, and your bottom line will show the result. 

Conclusion

All businesses have costs. The most common that get incurred through day-to-day operations are called operating expenses. These are the outlays necessary to keep your firm going. Knowing what they are means you know what you can write off on your tax return. Managing them sensibly, too, can help you grow your profit margins.