Operating Expenses: Definition and Examples

Operating Expenses: Definition and Examples

Understanding what goes into overhead costs can help you determine where your company can be more efficient and, ideally, more profitable.

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The Basics

What are operating expenses (OPEX)?

Operating expenses are the costs associated with running a business that are not direct ingredients or raw materials needed to make the products or services sold. Operating expenses are abbreviated “OPEX” and sometimes referred to simply as “overhead.” 

Operating expenses include (but aren’t limited to): 

Operating expenses are paid for with gross margin dollars. You can calculate operating profit (also referred to as operating income) by deducting operating expenses from gross margin. 

OPEX are tax-deductible in the United States (for businesses that earn a profit). 

Operating expenses on an income statement

Operating expenses appear below the line on a company’s income statement. They are sometimes represented as a single line item, or they may be broken out into multiple line items for different types of expenses.  

Note: Because Apple spends a lot on R&D, they choose to itemize and break out that line separately here. They also bucket Selling, General, and Administrative Expenses (often abbreviated SG&A) together. These costs are generally fixed, meaning they don’t vary directly with sales volume.

Operating expenses vs. capital expenditures

Whereas operating expenses are business expenses incurred by day-to-day operations of a business, capital expenditures are costs associated with major purchases—that is, purchases of assets a business will use for more than a year. So while rent on an office space is considered an operating expense, if a business were to purchase a new production plant to manufacture goods, that would be considered a capital expenditure. 

Other examples of capital expenses include: 

Capital expenditures have several key differences from operating expenses:

  1. They come out of a different budget.
  2. They are not fully tax-deductible in the year they are purchased; rather, they are deductible over time.
  3. They appear on a company’s balance sheet, rather than on the income statement

Operating expenses vs. non-operating expenses

Non-operating expenses are costs not associated with the core business operations. Examples include interest on financing, or other borrowing costs. 

Operating ratio

Operating ratio is a financial ratio that measures operational efficiency of a company. It’s calculated using the following formula:

Operating ratio = (Operating expenses + Cost of goods sold) / Revenue

The result is a percentage, which represents the portion of revenue that is spent on core operation of the business. Analysts want to see operating ratio decrease over time, as that suggests that a company is becoming more efficient and retaining a higher percentage of every dollar of revenue. 

What operating ratio doesn’t reflect is debt. That’s why it’s important to look at debt ratio as an additional metric when evaluating a company’s performance. 

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