Operating expenses are the costs that a business incurs to maintain its day-to-day operations. Examples include the non-manufacturing component of payroll, rent, office supplies, and utility costs. Operating expenses are essential for analyzing a company’s operational performance, as they affect both the gross profit and the net income of the company. In this blog post, we will explain what operating expenses are, how to calculate them, and how to manage them effectively.

How to Calculate Operating Expenses

Operating expenses can be calculated by subtracting the cost of goods sold (COGS) from the revenue or sales of the company. The cost of goods sold represents the direct and variable costs that are incurred to produce or acquire the goods or services that are sold by the company. These costs may include raw materials, labor, manufacturing overhead, packaging, and shipping. The revenue or sales represents the income that the company generates from its core business activities, such as selling products, providing services, or earning commissions.

The formula for calculating operating expenses is:

Operating Expenses=Revenue or Sales−Cost of Goods Sold

For example, if a company has $100,000 in revenue or sales, and $60,000 in cost of goods sold, its operating expenses are:

Operating Expenses=100,000−60,000=40,000

The operating expenses can also be expressed as a percentage of the revenue or sales, which is called the operating expense ratio. The formula for calculating the operating expense ratio is:

Operating Expense Ratio=Revenue or SalesOperating Expenses​×100%

Using the same example, the operating expense ratio is:

Operating Expense Ratio=100,00040,000​×100%=40%

This means that for every dollar of sales, the company spends 40 cents on operating expenses.

How to Manage Operating Expenses

One of the challenges that managers face is how to reduce operating expenses without compromising the quality and efficiency of the operations. Operating expenses are necessary and unavoidable for most businesses, but they can also erode the profitability and performance of the company if they are not controlled and optimized. Some of the strategies that managers can use to manage operating expenses are:

• Budgeting and forecasting: Managers should prepare a realistic and detailed budget for the operating expenses, based on the expected revenue, sales volume, and market conditions. The budget should also include a contingency plan for unexpected events or changes. Managers should monitor and compare the actual operating expenses with the budgeted ones, and adjust the budget accordingly if needed.

• Benchmarking and analyzing: Managers should compare the operating expenses of their company with those of their competitors and industry averages, and identify the areas where they can improve or reduce costs. Managers should also analyze the trends and patterns of the operating expenses over time, and identify the factors that influence them, such as seasonality, inflation, or technology.
• Negotiating and outsourcing: Managers should negotiate with their suppliers, vendors, and service providers to get the best prices and terms for the goods and services they need for their operations. Managers should also consider outsourcing some of the non-core or low-value activities to external parties, such as accounting, marketing, or IT, if it can lower the operating expenses and improve the quality and efficiency of the operations.
• Automating and innovating: Managers should leverage technology and innovation to automate and streamline some of the processes and tasks that are involved in the operations, such as inventory management, order processing, or customer service. This can reduce the operating expenses by saving time, labor, and resources, and also enhance the accuracy and productivity of the operations.

Conclusion

Operating expenses are the costs that a business incurs to maintain its day-to-day operations. They are calculated by subtracting the cost of goods sold from the revenue or sales of the company, and can also be expressed as a percentage of the revenue or sales, which is called the operating expense ratio. Operating expenses are important for measuring the operational performance and profitability of the company, and managers should manage them effectively by using strategies such as budgeting, forecasting, benchmarking, analyzing, negotiating, outsourcing, automating, and innovating.