Operating Expenses

Operating expenses, often shortened to OpEx, are the costs a company incurs to run its core business that are not part of the direct cost of producing the goods or services it sells. They include salaries of sales and administrative staff, office rent, utilities, marketing and advertising expense, insurance, travel, research and development, and depreciation of non-production assets. On a multiple-step income statement, operating expenses are subtracted from gross profit to arrive at operating income.

Operating expenses are distinct from cost of goods sold, which covers the materials, labor and factory overhead directly tied to products, and from nonoperating expenses such as interest. They are also different from capital expenditure: spending on long-term assets is capitalized and only enters operating expenses gradually, through depreciation and amortization.

• Selling expenses: sales salaries and commissions, advertising, promotions, delivery to customers (freight-out) and sales office costs.
• General and administrative expenses: executive and office salaries, accounting and legal fees, head office rent, IT, insurance and utilities.
• Research and development: costs of developing new products and technologies, which under US GAAP are generally expensed as incurred.
• Depreciation and amortization of assets used in selling and administration, such as office buildings and software.

Many companies combine selling, general and administrative costs into a single line labeled selling, general and administrative expenses. Classification can vary: a software company may treat hosting costs as cost of revenue, while another treats similar costs as operating expenses, so comparisons between companies require care.

A consumer products company reports revenue of $50,000,000 and cost of goods sold of $30,000,000, giving gross profit of $20,000,000. Its operating expenses are selling expenses of $7,000,000, general and administrative expenses of $5,500,000 and research and development of $2,500,000, a total of $15,000,000. Operating income is $5,000,000. The operating expense ratio is:

Here $\text{Operating expenses}$ is total OpEx for the period and $\text{Net sales}$ is revenue after returns and discounts. The ratio is $15,000,000 divided by $50,000,000, or 30 percent, and the operating margin is 10 percent. If the company grows sales by 20 percent next year while holding operating expenses flat, operating income rises to $9,000,000, assuming the same gross margin. That shows the effect of operating leverage: when a large share of operating expenses is fixed, profits grow faster than sales.

Most operating expenses are period costs: they are expensed in the period they are incurred, rather than being held in inventory until sale. Under accrual accounting they are recognized when the resource is used, not when paid, so year-end adjustments record unpaid wages, utilities and professional fees, and spread prepaid items such as insurance expense over the coverage period. Noncash operating expenses, such as depreciation and share-based compensation, are added back when calculating operating cash flow.

Analysts track operating expenses as a percentage of sales over time and against peers to judge cost discipline. Rising selling costs without matching sales growth may indicate weaker demand or higher customer acquisition costs. Measures such as EBITDA strip out depreciation and amortization from operating expenses to compare cash-generating ability. Common issues include classifying ordinary operating costs as one-off "restructuring" items to flatter adjusted profit, and capitalizing costs that should be expensed, which moves them from operating expenses into capital expenditure. Under IFRS 18, effective from 2027, companies will also need to disclose more detail on operating expenses by nature when they present them by function.