Operating Expenses: Definition, Formula & Examples
This lesson introduces the concept of operating expenses. It explains what operating expenses are and how they are calculated. Examples of operating expenses are included to help you understand their impact on a business.
What Are Operating Expenses?
Operating expenses can greatly impact the profitability of a business and how much cash it has. Operating expenses are the costs a company incurs that are not related to the production of a product. These expenses include items like payroll, rent, office supplies, utilities, marketing, insurance, and taxes.
Operating expenses are essentially the costs to keep the business running. The more the operating expenses are, the less cash the business keeps. Because operating expenses can be a substantial drain on company resources, controlling operating expenses is an important aspect of managing a financially healthy business.
Formula
Operating expenses are found on the income statement. Every company will have different expenses based on their operations. A basic example of an operating expenses formula is below.
Operating expenses = license fees + office expenses + legal fees + insurance + travel and vehicle expenses + salaries and wages + accounting expenses + maintenance and repairs + supplies + advertising + utilities + property taxes
While this is a short list of common operating expenses, every company will have operating expenses that are unique to its needs. These expenses would be added to the list of operating expenses on the income statement and calculated with the other costs.
Examples
Operating expenses are often divided into two categories: marketing and administrative.
- Marketing expenses are the costs of promoting products and services. Marketing expenses include items like business and stationery printing, sales salaries, commission expenses, trade show booths, advertising, brochure printing, direct marketing expense, television and radio advertising, and print advertising.
- Administrative expenses are the necessary expenses that are incurred in the course of running a business and are not directly tied to a specific product or service. Administrative expenses include items like:
- office salaries
- office supplies
- maintenance and repairs
- professional fees
- credit card fees
- interest expenses
- insurance
- depreciation expenses
These are just examples and the actual list will vary based on the needs of the company.
Lesson Summary
Let’s review. Operating expenses are the costs a company incurs that are not related to the production of a product. They are an important factor in evaluating the fiscal health of a company.
When calculating operating costs, the expenses not directly tied to the production of products are included. If operating expenses are not managed, a company’s cash flow can be greatly affected, leaving the company with less income than is necessary.
These expenses are typically broken into two categories: marketing expenses and administrative expenses and are reported on the company’s income statement.
Operating Expenses Key Terms
- Operating expenses: the costs a company incurs that are not related to the production of a product
- Marketing expenses: the costs of promoting products and services
- Administrative expenses: the necessary expenses incurred during the course of running a business that are not directly tied to a specific product or service
Learning Outcomes
Discover whether you can achieve these objectives as a result of watching the lesson:
- State the definition of operating expenses
- Identify the formula for figuring operating expenses
- Reference examples of operating expenses
Additional Activities
Calculating Operating Expenses – A Business Case
The business case below will help you practice identifying and calculating operating expenses.
You are an accounting clerk at Systems Meds Inc and your manager has just asked to come by his desk.
“We have a listing of expenditures from the past week that has not yet been recorded in the general ledger. Since you are in charge of operating expenses, can you look over this listing and identify which of these are operating expenses and also compute the total operating expenses? I will take care of posting the summary journal entry later on.”
The listing is provided below.
| Item | Amount ($) |
|---|---|
| Pencils and other stationery | 24.05 |
| Payroll processing fee | 64.85 |
| Maintenance on corporate vehicles | 297.62 |
| Interest charge on business loan | 248.95 |
| Purchase of raw materials from suppliers | 753.69 |
| Plane ticket for CEO to visit a distant warehouse | 862.35 |
| Lawyer fees for consultation session on Tuesday | 475.32 |
| Insurance policy purchased for next year | 1,425.36 |
Solution:
| Item | Amount ($) | Included? | Notes |
|---|---|---|---|
| Pencils and other stationery | 24.05 | Yes | |
| Payroll processing fee | 64.85 | Yes | |
| Maintenance on corporate vehicles | 297.62 | Yes | |
| Interest charge on business loan | NIL | No | Interest expense is not included in operating expenses and is reported separately. |
| Purchase of raw materials from suppliers | NIL | No | The purchase of raw materials relates to inventory, not operating expenses. |
| Plane ticket for CEO to visit a distant warehouse | 862.35 | Yes | |
| Lawyer fees for consultation session on Tuesday | 475.32 | Yes | |
| Insurance policy purchased for next year | NIL | No | The insurance policy is for a subsequent period and thus is a prepaid expense. |
We know that the following is a list of different types of operating expenses that a company may have. Although there can be other expenses beyond this list depending on the company, this gives you the accounting clerk a good reference point in order to fulfill the request of your boss:
Total operating expenses = license fees + office expenses + legal fees + insurance + travel and vehicle expenses + salaries and wages + accounting expenses + maintenance and repairs + supplies + advertising + utilities + property taxes
= $24.05 + $64.85 + $297.62 + $862.35 + $475.32 = $1,724.19