Operating expenses, or OPEX, are the ongoing costs and expenditures a business incurs as part of its day-to-day operations to generate revenue. These expenses, while essential for maintaining and running the business, do not directly contribute to the production of goods or services. OPEX is deducted from a company’s revenue to calculate its operating profit or operating income.
OPEX is part of a company’s income statement and is subtracted from gross profit to determine the operating profit or earnings before interest and taxes (EBIT). Managing and controlling OPEX is critical to maintaining profitability, and businesses often seek to optimize these costs while ensuring they do not compromise essential functions and services. Reducing OPEX can lead to increased net income and improved financial performance.
Common examples of OPEX include:
Employee Salaries and Benefits: The costs associated with paying wages, salaries, and benefits to employees, including salaries of non-production staff such as administrative, sales, and management personnel are considered OPEX.
Rent and Leases: Payments for office space, manufacturing facilities, warehouses, or other real estate properties used in the business are OPEX.
Utilities: OPEX includes costs for electricity, water, gas, and other utilities necessary for the business’s daily operations.
Office Supplies: OPEX also covers costs for office supplies and other materials for employees to do their jobs.
Insurance: Premiums for various types of insurance, including liability insurance, property insurance, and workers’ compensation insurance fall under OPEX.
Repairs and Maintenance: OPEX includes expenses for maintaining and repairing equipment, machinery, vehicles, and facilities to keep them in working order.
Advertising and Marketing: Any cost associated with advertising, marketing campaigns, and promotions falls under OPEX.
Travel and Entertainment: Expenses related to business travel, accommodations, meals, and entertainment for employees, clients, or business partners are OPEX.
Professional Services: Payments to lawyers, accountants, and other professional service providers for their services to the business are OPEX.
Taxes: Various taxes, such as property taxes and business taxes, paid to local or federal authorities are OPEX.
Depreciation: This OPEX refers to a non-cash expense that accounts for the decrease in the value of long-term assets over time.
Licenses and Permits: OPEX includes costs for obtaining necessary licenses and permits to operate legally in specific jurisdictions.
Office Equipment Rental: Rental expenses for office equipment, such as copiers and printers fall under OPEX.
Bank Charges and Interest: OPEX covers fees and interest charges related to loans, credit lines, and banking services.
Subscriptions and Memberships: The costs for business-related subscriptions, memberships, and industry association fees are OPEX.
Non-operating expenses are costs that are do not directly relate to a company’s primary business operations. These expenses typically don’t impact the core operations and revenue generation of the business but affect the company’s overall financial performance. Here are some examples of non-operating expenses:
Interest Expense: This expense refers to the interest paid on loans or debt obligations.
Foreign Exchange Losses: This refers to losses incurred due to currency exchange rate fluctuations.
Unrealized Investment Losses: This expense deals with losses on investments that a company holds but has not yet sold. These are recorded on the income statement even if the investments have not been realized.
Litigation Costs: This covers legal expenses not directly related to the company’s primary operations.
Impairment Charges: These are charges related to the reduction in the value of assets.
Restructuring Costs: These costs are associated with major organizational changes, such as employee severance payments, facility closures, or reorganization expenses.
Income Tax Provision: This is the tax expense a company records on its income statement, which is not directly tied to the day-to-day operations.
Donations and Contributions: Any donations to charity made by the company fall under this category.
Loss on Disposal of Assets: The loss incurred when a company sells or disposes of assets, such as property, plant, or equipment, for less than their book value.
Loss from Investments in Affiliates: These are losses from investments in affiliated companies or joint ventures in which the business has a stake.
Exchange Rate Gains: These are gains from favorable currency exchange rate fluctuations.
Financing Fees: The expense covers any fees paid to banks, financial institutions, or advisors for services related to financing activities, such as arranging loans or credit lines.
Loss on Debt Extinguishment: This category includes charges incurred when a company repurchases or retires its debt at a price lower than the carrying amount of the debt.
Rental Income: Although rental income is revenue, if it is not part of the company’s primary operations it is considered a non-operating source of income.
Gains or Losses on Sales of Investments: The category is for gains or losses from selling investments or securities that the company holds as part of its financial portfolio.
To calculate OPEX use the following formula:
OPEX = Expense 1 + Expense 2 + Expense 3 + … + Expense N
OPEX includes cost categories such as salaries, rent, utilities, office supplies, marketing, and more. These costs are subtracted from the company’s gross profit to determine the operating profit (or earnings before interest and taxes, EBIT).
OPEX is typically found on an income statement, which is also known as a profit and loss statement. An income statement provides a summary of a company’s financial performance, including its revenues, expenses, and net income for a specific period.
To find OPEX on an income statement:
Locate the Income Statement: A business’ income statement is typically included in its annual or quarterly reporting. A business often includes its income statement in financial reporting distributed to shareholders, investors, and other stakeholders.
Identify the Expense Section: On the income statement, look for the section that lists various expenses. These expenses are categorized and reported separately to provide transparency into the company’s costs.
Find OPEX: Within the expense section, there is typically a category labeled “Operating Expenses,” which may be divided into subcategories.
Review the Line Items: Under OPEX and its subcategories, the individual line items that represent specific costs incurred by the company during the reporting period will appear.
Calculate the Total: To find the total OPEX add up all the individual line items listed.
Net Income Calculation: OPEX is subtracted from the company’s total revenue to calculate the operating profit (or earnings before interest and taxes, EBIT). The net income is then calculated by further subtracting non-operating expenses (such as interest and taxes) from the operating profit.
Here is an example OPEX report for a SaaS company:
Employee salaries and wages
Sales and marketing
Office rent and utilities
Professional services, including legal
Travel and conferences
Other misc. expenses
In this example, the total of these expenses is considered the company’s OPEX for the period. Operating profit is then calculated by subtracting these OPEX from total revenues. Non-operating expenses, such as interest and income tax, are accounted for separately.
The OPEX Ratio (OER), also known as the Expense Ratio or Operating Expenses as a Percentage of Revenue, measures the efficiency of a company’s operations by comparing its operating expenses to its total revenue. A good OER can vary significantly depending on the industry, business model, and company size. However, in general, a lower OER is often considered more favorable, as it suggests that a company is operating efficiently and has better control over its costs.
To calculate the OER, use the following formula:
OER = (Operating Expenses / Total Revenue) × 100
Here are a few considerations when evaluating the OER:
What is considered a good OER can differ by industry. Some industries naturally have higher operating expenses, and others are more cost-efficient. Therefore, it’s essential to compare your OER to industry benchmarks.
Larger companies may have economies of scale that allow for lower OER. Smaller companies might have higher OER due to their size and limited resources.
The OER should be assessed in conjunction with profit margins. A low OER is beneficial, but not if it comes at the expense of profit margins. A company should aim to lower operating expenses without sacrificing profitability.
A company should compare the current OER to historical data to provide insights into a company’s cost management efforts. If the OER is improving over time, it may indicate better efficiency.
By analyzing the breakdown of operating expenses, a company can see if reducing certain types of expenses might have a more significant impact on efficiency and profitability than others.
Companies in the growth stage might have higher OER as they invest in scaling their operations. Established companies may aim for lower OER.
Economic conditions can affect operating expenses. For instance, inflation can increase costs, and a competitive market might require higher marketing expenditures.
Companies with a focus on operational excellence and continuous improvement often achieve lower OER.