What are operating expenses: Types, calculation, and cost-saving strategies

Ever wonder how a company can look successful but still struggle to stay afloat? Often, it boils down to operating expenses.

Operating expenses, or OpEx for short, are the ongoing expenses a business incurs from its day-to-day operations. They’re the costs of keeping the lights on and the business running — such as rent, salaries, utilities, and marketing.

Whether you’re a tech giant or a local bakery, operating expenses can significantly impact your company’s profitability and long-term viability.¹ In this guide, we’ll answer the important questions, like what are operating expenses and, more importantly, what are some smart strategies for keeping these costs in check?

What are operating expenses?

Operating expenses are regular, recurring expenses that maintain the essential functions of a business. If they’re not managed correctly, they may cause financial instability and hinder growth — that’s why it’s so important to track expenses diligently and understand where your money is going.

So, what are considered operating expenses? They typically encompass a wide range of day-to-day costs, but often differ between industries. For example, a software company might have higher technology expenses, while a retailer might spend more on inventory storage.

Notably, operating expenses exclude costs directly associated with producing goods or services (cost of goods sold) and long-term investments or physical assets (capital expenditures).

What is included in operating expenses?

Here are some common examples of operating expenses that businesses may incur:

• Salaries and wages: Compensation paid to employees, including regular salaries, wages, and benefits like healthcare, retirement contributions, and paid time off.
• Rent and utilities:  Fixed costs associated with leasing or owning office, retail, or manufacturing spaces, as well as expenses for utilities like electricity, water, heating, and internet.
• Office supplies: Materials and supplies needed for daily operations, like paper, pens, and coffee.
• Software and technology: Expenses for software licenses, IT services, and technology upgrades.
• Insurance: Premiums paid for various types of insurance coverage, such as liability insurance, property insurance, and business interruption insurance.
• Marketing and advertising: Costs related to promoting the business, including advertising campaigns, marketing materials, public relations, and digital marketing.
• Maintenance and repairs: Expenses for maintaining and repairing equipment, machinery, vehicles, and facilities.
• Professional services: Payments to external consultants, legal advisors, and accountants for specialized services and expertise.
• Taxes and licenses: Payments for business licenses, permits, and various taxes.
• Depreciation: The decrease in value or wear and tear that an asset experiences as it’s used in business operations.
• Travel: Expenses incurred for business-related travel, accommodations, and client meetings.

What are non-operating expenses?

Non-operating expenses fall outside of core operations. In other words, they’re not directly related to generating revenue or producing goods and services.

Some common non-operating expenses include:

• Interest payments on debt: Interest incurred on loans.

• Restructuring costs: Expenses associated with reorganizing or restructuring a business, such as severance pay or asset write-downs.

• Legal settlements: Payments made to settle lawsuits or legal disputes.

• Losses from asset sales: Financial losses when selling assets below their book value.

• Currency exchange losses: Costs resulting from unfavorable fluctuations in foreign exchange rates.

How to calculate operating expenses

When it comes to understanding how to calculate operating expenses, it’s important to note that there isn’t a strict mathematical formula. Instead, the process involves identifying and categorizing all relevant expenses that contribute to the daily operations of a business, and then adding them up.

To calculate operating expenses, follow these steps:

1. Identify and categorize expenses: Break down your expenses into categories, such as administrative costs (for example, office supplies and HR salaries), selling costs (like advertising and sales team salaries), utilities, and other general expenses (for example, electricity and insurance).
2. Exclude non-operating costs: Filter out costs like taxes, interest, cost of goods sold (COGS), and capital expenditures.
3. Add them up: Once you’ve categorized all relevant costs, add them up to find your total operating expenses.

Importance of managing operating expenses

When business owners learn how to manage operating expenses, they can work to bolster profitability and sustainability. This is especially important in the early stages of a business, when startup costs are high and revenue might flow in slowly and unpredictably.

Here are some top benefits businesses enjoy when managing operating expenses effectively:

• Profitability: Operating expenses can directly impact a company's profitability. While increasing revenue is one way to boost profit, reducing unnecessary expenses can quickly and directly impact a company’s bottom line.
• Cash flow management: When expenses are controlled, a business can ensure that its cash inflows (revenue) are sufficient to cover its cash outflows (expenses). This is essential for meeting immediate financial obligations, such as paying employees, suppliers, and creditors.
• Resource allocation: By analyzing and managing expenses, a company can allocate its resources more efficiently, such as reallocating funds from less productive areas to those that drive growth.
• Growth opportunities: By reducing operating expenses, a company can free up funds to reinvest in the business.
• Resilience: Businesses with well-managed operating expenses can better navigate challenging times like economic downturns, natural disasters, or supply chain disruptions.
• Debt management: By keeping operating expenses in check, a company can avoid unnecessary debt and the associated interest payments.
• Long-term viability: Effective expense management helps prevent excessive spending that could otherwise erode profitability and hinder growth.

Strategies for reducing operating expenses

Looking to cut costs? Once you’ve listed and analyzed your spending, you can better understand where your money is going and identify opportunities for reducing operating expenses.

Here are some quick strategies to help get you started:

• Renegotiate contracts: You don’t have to accept the first offer. Review contracts for services like rent, utilities, and insurance regularly. You might be able to secure better rates by negotiating with your current providers or exploring alternatives.

• Embrace digital marketing: Traditional advertising can be expensive. Explore cost-effective digital marketing strategies like social media marketing, content marketing, and search engine optimization (SEO) to reach your target audience online.

• Outsource strategically: Consider outsourcing non-core functions, like IT support, payroll processing, and customer service to specialized vendors. They can often handle these tasks more efficiently and cost-effectively than in-house teams.

• Minimize waste: Implement waste reduction strategies to minimize material and resource use, such as recycling, reusing materials, and optimizing production processes.

• Automate with technology: Invest in technology solutions that can automate tasks, improve efficiency, and reduce labor costs. This can include software for inventory management, customer relationship management (CRM), and accounting.

• Embrace flexibility: Explore remote work and flexible scheduling options, which can reduce office space costs and improve employee satisfaction.

• Negotiate with suppliers: Build strong relationships with your suppliers and don’t be afraid to negotiate better deals. Bulk purchasing or long-term contracts may lead to cost savings.

• Optimize inventory: Holding onto too much stock can tie up your cash and even lead to losses if items become outdated or spoil. "Just-in-time" inventory methods can help you avoid these pitfalls by ensuring you only receive inventory when you need it.

• Control travel costs: If your team travels for work, put savvy policies in place. Can you swap some trips for video calls? Can you negotiate discounts with airlines and hotels? Make sure to set clear travel expense guidelines as well.

• Promote employee engagement: When your team feels valued and engaged, they're more likely to stick around and do their best work. Investing in employee morale can actually save you money in the long run by reducing costly turnovers and the need to constantly hire new people.

Remember: It’s important to regularly monitor your progress and adjust your strategies as needed.

Operating expense budgets and forecasting

As you strategize ways to reduce certain operating expenses, consider building a realistic operating expense budget and financial forecast to keep your business on track. These tactics can provide a structured approach to planning, allocating resources, and tracking performance.

Plus, budgeting and forecasting can align financial goals with strategic objectives. In other words, ensuring that expenses are directed toward activities that contribute to an organization's success.

Not sure where to start? Several software and tools are available to streamline the tracking and management of operating expenses, with features like budgeting, expense categorization, and reporting. When choosing a tool, consider factors like your business size, budget, desired features, and integration capabilities with your existing systems.

When it comes to setting practical expense targets, best practice is to contact a financial services professional like an accountant or strategic planner to create a tailored approach for your business.

How can small businesses avoid common operating expense mistakes?

Money management can be challenging for new and small businesses, as they often encounter common operating expense mistakes that can affect financial stability — from poor cash flow management to unexpected costs.

Beware of these common pitfalls:

• Mixing personal and business finances: Maintain clear separation between personal and business expenses by using dedicated accounts and payment methods. Keep detailed records to avoid confusion.
• Neglecting expense tracking: Use expense tracking tools to record and categorize all expenses accurately. Regular reconciliation can help identify discrepancies.
• Ignoring small expenses: Pay attention to small, recurring expenses, as they can accumulate over time.
• Underestimating hidden costs: Factor in hidden costs like maintenance, upgrades, or taxes when estimating expenses.
• Impulse spending: Consult your budget and evaluate the necessity and long-term value of purchases before making them.
• Not seeking professional advice: Seek financial advice from experts, as their insights can guide effective expense management and decision-making.