Summary
This article explains the concept of operating expenditure or OpEx and provides relevant examples. It also delves into the various types of OpEx, and what expenditure heads are included and excluded from the computation of OpEx. The article also discusses the applicability of OpEx in determining and comparing the financial results of firms.
Operating expenditure is the cost incurred by a firm in the day-to-day running of a business to generate revenue. It includes only those expenses that arise directly from the operations of the firm. Due to this reason, operating expenses differ from company to company and also depends on the industry the company operates in. You must understand that an operating expense for one company could be a non-operating item for another company. For example, interest paid on deposits is an operating expense item for a financial institution like JPMorgan. However, if a company in the technology business like Apple receives interest on deposits, it is a non-operating item. Now let us examine a few examples of operating expenditures to understand it better.
Examples of operating expenditures
Operating expenditures include:
- Cost of Goods Sold or COGS (including wages, materials costs, and cost of energy consumption).
- Selling, General, and administrative expenses or SG&A expenses (including salaries, rent, utilities, legal and accounting expenses, office supplies, bank charges, and marketing costs)
- Research and Development expenses or R&D expenses
- Depreciation and Amortization
A firm must necessarily manage the above-mentioned expense items in relation to its revenues in order to achieve maximum profitability. Also, a business must ensure that it is not sacrificing on the quality of its products and services, while trying to curtail OpEx, which would affect future sales. Compromising on product quality in relation to alternatives could also provide a boost to a company’s competitors, and result in declining sales. Hence, a fine balance exists between OpEx, revenues, and profitability.
Comparing fixed versus variable OpEx
Operating expenses can be fixed or variable in nature. Fixed OpEx is set for a certain period. It does not change based on the level of a firm’s operating activity. For example, factory rent is typically a fixed cost which could be payable monthly or annually. It does not change based on the production level maintained by the factory which could fluctuate based on demand for the product and other considerations. Examples of fixed OpEx include:
- Rent
- Salaries payable to staff
- Bank charges
- Legal and audit fees
- Telecommunication expenses if the company is on a telecom plan
- Insurance payments
Variable expenses on the other hand, fluctuate depending on the operating level of the company. These costs are determined by the production and/or sales levels of the company. These are also referred to as direct costs as they are incurred as the firm ramps production levels up or down as the case may be. For example, direct materials costs are typically incurred in the production process. If a firm produces more units of a commodity, it will increase direct materials expenditure, and vice versa. Examples of variable OpEx include:
- Materials costs
- Wages to factory employees
- Utilities expenses incurred on energy consumption
- Selling expenses
Applicability of OpEx
The income statement provides a summary of a company’s financial performance over a particular period, such as a quarter or a year. OpEx is deducted from operating revenues in the income statement to determine a company’s operating income/loss.
Operating income margins, or operating income/loss divided by operating income make it easier to compare businesses operating in the same industry, and those operating in other industries as well. For example, in the aerospace & defense industry, an analyst could compare the operating income margins of companies like Boeing, Airbus, Lockheed Martin among others to determine their relative performance. You could also make comparisons between companies operating in different sectors and industries such as Walmart and Microsoft to determine which sector or industry is more profitable. Companies with higher operating income margins are more profitable and preferrable compared to firms with lower operating income margins, and vice versa.
Exclusions from OpEx
Although finance charges and taxes form part of the deductions in the income statement used to determine net income, these expenses are not considered to be part of OpEx and not deducted in order to compute operating income/loss. This is because it is up to the discretion of the individual firm whether to employ leverage or not, and how much debt it chooses to undertake. Besides, financing costs and applicable tax rates can be different for different firms, and dependent on the jurisdictions they operate in. Due to these reasons, they tend to skew results from operations and are therefore excluded from OpEx. As a result, they are also termed as non-operating expenses.
However, finance charges are tax-deductible and form part of the income statement in order to determine taxable income. Further, income taxes are deducted from taxable income to determine net income available to owners.
In conclusion
OPEX is the day-to-day costs of running a business. This encompasses essential expenses like utilities, salaries, rent, and maintenance. By closely monitoring and managing OPEX, businesses can optimize their budgets and maintain profitability.