Definition of operating expenses
Operating expenses include expenses such as rent, legal or accounting fees, marketing, inventory costs, marketing, sales or sales commission, insurance, payroll and travel expenses. Funds that businesses usually allocate towards research and development also fall under the operating expenses category.
Understanding the importance of operating expenses
Operating expenses (OPEX) are an integral part of any business. It’s not possible for a company to function without incurring any costs.
Expenses incurred by a business are reflected mainly on the income statement and is one of the main components that determine operating income. The income statement also provides selling general and administrative expenses (sometimes abbreviated as SG&A). This segment does include costs related to direct as well as indirect selling apart from listing down all the general and administrative expenses.
Most businesses are keen to reduce their operating costs and increase revenue. Properly doing this will give a business a competitive advantage over its competitors and peers. Some firms can do this with ease, while others suffer because they do not have a proper plan in place.
The quality of business operations can fall when a business decides to reduce the costs related to core operations.
CAPEX (also CapEx) is the abbreviation for capital expenses in the accounting world. Any purchase that a business makes towards investment falls under this category. This includes upgrading tangible and intangible assets. Computers, office furniture, factory equipment, real estate, and other physical assets fall under tangible assets. Patents, registered trademarks, intellectual property, copyrights are classified as intangible assets.
Operating expenses versus capital expenses
The ATO treats operating expenses differently from capital expenses. As per the ATO, any ordinary or everyday expense that most businesses accept as an operating cost is an operating expense.
Companies also have the advantage of writing off all operating costs that they incurred within a financial year. At the same time, businesses benefit when they capitalise capital costs.
When a business spends $100,000 on payroll it is an operating expense.
When the same business spends $100,000 to purchase a vehicle or the factory equipment it’s a capital expense. In the first case, the business can write off the $100,000 in the tax year that the OpEx occurred. In the second case, the business needs to expense the asset over several years. This will depend on the useful life of the asset and other rules set by the ATO. One exception is the $30,000 instant asset write-off which makes it possible to write off the total capital expenditure in a single year if the asset costs less than $30,000. Find out more in How to Unlock the Full Benefit of the $30,00 Instant Asset Write-Off.
Operating expenses versus non-operating expenses
Almost any expense that is unrelated to core business operations falls under non-operating costs. Interest expenses or charges, amortisation, depreciation, loans, and other similar expenses types are some of the everyday non-operating expenses. Most accountants remove non-operating costs to check and see how a business is performing.
Operating expenses on the income statement
An income statement is one of the most crucial financial documents that a company uses to check its profits and its progress. The expenses a business incurs falls under any of these six main groups:
- Selling, general and administrative costs
- Costs of goods sold
- Depreciation and amortization
- Income taxes
- Interest expenses
- Other operating expenses.
All these are considered to be operating expenses. But when determining operating income with the help of the income statement, it’s necessary to exclude interest expenses as well as income tax.
Other examples of operating expenses
- Sales commission
- Compensation related to payroll tax and cost for employees (non-production)
- Benefits for employees (non-production)
- Contributions to the pension plan for employees (non-production).
Expenses related to running an office:
- Insurance costs
- Accounting expenditures
- Legal fees
- Office supplies
- Utility costs or expenses
- Property taxes
- Repair costs towards non-production facilities
- Rent costs towards non-production facilities
- Depreciation of assets (fixed) used in non-production areas.
Expenses related to sales and marketing:
- Entertainment costs
- Travel costs
- Direct mailing costs
- Advertising costs
- Material costs for sales (brochures).
Here’s a list of operating costs from the ATO.
Here are two definitions that will help you understand operating expenses:
Cost of Goods Sold: COGS or cost of goods sold refers to the direct expenses you can attribute to the production and sale of products that a company makes. This includes the costs of materials that are used and the labour costs involved in making a product. Distribution and sales force expenses are, however, excluded from this as they are indirect expenses.
Capitalisation: When capitalising an expense by recording it on a balance sheet, you delay the full recognition of a particular cost until a later date. This is beneficial for companies, especially when they buy equipment or an asset that has a longer lifespan as they can amortise the costs (spread them over time).