Understanding Operating Expenses: A Simple Guide

Operating expenses, or OpEx for short, are very important when looking at a company’s income statement.

These expenses are the everyday costs that keep a business running. However, they do not include the costs of making the products sold (which are called Cost of Goods Sold, or COGS).

When you understand how operating expenses affect your income statement, it can help you make better financial decisions.

Types of Operating Expenses

We can split operating expenses into two main groups:

1. Fixed Expenses: These stay the same no matter how much a business produces or sells. They include things like rent, salaries, and insurance.

2. Variable Expenses: These change based on how much the business is doing. Examples include utility bills, sales commissions, and the cost of materials.

How They Affect the Income Statement

The income statement is also known as the profit and loss statement. It shows how much money a business makes (revenue), how much it spends, and its overall profit over a specific time.

Operating expenses are deducted from total revenue to find the operating income. This number is very important because it indicates how profitable a company is.

Let’s look at a simple example using a pretend company called ABC Corp:

• Total Revenue: $200,000
• Cost of Goods Sold (COGS): $80,000

First, we calculate the Gross Profit:

• Gross Profit = Total Revenue - COGS
• Gross Profit = $200,000 -$80,000 = $120,000

Next, we consider the operating expenses:

• Fixed Expenses: $50,000 (like salaries and rent)
• Variable Expenses: $30,000 (like utilities and commissions)

To find total operating expenses:

• Total Operating Expenses = Fixed Expenses + Variable Expenses
• Total Operating Expenses = $50,000 +$30,000 = $80,000

Now we can find the operating income:

• Operating Income = Gross Profit - Total Operating Expenses
• Operating Income = $120,000 -$80,000 = $40,000

Important Points to Remember

1. Checking Profitability: Operating expenses have a big impact on how much profit a company makes. If these costs go up too much, they can take away from profits, so it's crucial to keep an eye on them.

2. Budgeting and Planning: Knowing about operating expenses helps businesses make better budgets and plans. For example, if ABC Corp thinks sales will go up, it might decide to spend more on variable expenses like commissions.

3. Spotting Trends: Keeping track of operating expenses over time can show how well a business is running. If fixed expenses keep going up without more revenue, that could mean the company is in trouble financially.

In summary, operating expenses are key players in a company’s income statement. They affect gross profit and operating income. For a business to stay profitable, it must regularly track and manage these expenses. This way, they’ll have the information needed to make smart financial choices.