Some business owners are a little fuzzy when it comes to classifying operating costs. In this guide, we’ll break down the definition of operating expenses, what is included in operating expenses, and some pro tips for managing your budget.
Operating expenses are defined as expenses that your business incurs to run normally. These expenses cannot be avoided and are required to help the business operate. The list of operating expenses includes things like equipment, inventory management costs, and payroll.
Operating expenses are found on a company’s income statement. Some business owners confuse overhead and operating costs. Overhead is slightly different: overhead expenses are other costs not related to labor, direct materials, or production. “Overhead costs are related to the general business, fairly fixed, and can be reviewed often to make adjustments. Operating costs are the direct costs required to produce a product or service and are difficult to avoid,” explains Investopedia.
Operating costs are usually classified as fixed or variable. Fixed operating costs are expenses that remain constant for a certain time period and do not vary as a result of output: things like rent, interest payments, or insurance payments. Comparatively, variable costs are impacted by the production and sales of your product or service. Advertising is considered a variable cost.
The IRS permits businesses to deduct operating expenses if the business operates to earn profits. As a result, it’s worth doing a deeper dive to see what is included in their definition of business operating expenses. Your operating costs could include things like:
Of course, there are also vertical-specific operating costs to be aware of. Some of the main operating costs restaurants will incur include: food, equipment, and wages. Brick-and-mortar retailers are managing store rent, wages, and product delivery and storage. Service businesses have operating costs, too, including utilities, travel, and equipment maintenance costs.
Many businesses create operating expense categories such as payroll-related expenses, administrative expenses, and sales and marketing expenses. These buckets can help you stay organized when it comes time to file your taxes.
It’s worth noting that inventory itself is not an operating cost. Inventory is considered part of Cost of Goods Sold (COGS). However, inventory management expenses can be counted under operating expenses.
Most businesses use an accounting tool, Excel sheet, or reporting software to calculate their operating expenses. These are the simplest options for understanding your small business operating expenses. Alternatively, you can add them all by hand: the formula might look something like this example from Indeed.
Operating expenses = accounting supplies + expenses on office supplies + insurance + licensing fees + legal fees + marketing and advertising + payroll and wages + repairs and equipment maintenance + taxes + travel + utilities + vehicle expenses
Integrating accounting software with your Clover POS can help you track key metrics related to your cash flow, including operating expenses, to determine when you might need to seek additional funding or tighten up your spending. Plus, get real-time sales reports that can help you better strategize your operating expenses according to best-selling items, foot traffic, and seasonal sales changes.
Operating expenses can give you a clearer picture of your business’ financial performance. Many ventures appear profitable when using the simple break-even calculation of subtracting COGS from revenue. However, this equation ignores operating expenses — which can tell a very different story.
Track and analyze all your expenses to better understand your cash flow and improve financial planning. Implement a system to record all expenses and categorize them to identify areas where you could potentially cut back, if needed. Regularly review your expense reports to identify areas of high spending, and look for ways to optimize your operations.
If you do need to cut back on operating costs, consider these strategies.
Ultimately, managing your small business operating expenses is a balancing act between keeping costs low and maintaining the quality of your products or services. By paying attention to your operating budget, you can continue to serve customers while keeping your operations lean and competitive.
Learn how Clover can help you get deeper insights about your business’s financials. Talk to a Clover Business Consultant today.
This information is provided for informational purposes only and should not be construed as legal, financial, or tax advice. Readers should contact their attorneys, financial advisors, or tax professionals to obtain advice with respect to any particular matter.
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