Operating expenses: Overview, definition, and example
What are operating expenses?
Operating expenses are the costs a business incurs during its day-to-day operations to produce goods or deliver services. These expenses include items like rent, utilities, salaries, marketing, and office supplies, but they exclude costs related to financing, taxes, or capital investments. Operating expenses are critical for maintaining a business’s regular operations and directly impact profitability.
Why are operating expenses important?
Operating expenses are important because they represent the ongoing costs of running a business. Monitoring and managing these expenses can significantly impact a company’s financial health and efficiency. By controlling operating expenses, businesses can improve profitability without needing to increase revenue.
For investors and stakeholders, operating expenses provide insight into how efficiently a company is managed. Excessive operating expenses may indicate inefficiencies, while streamlined expenses can reflect strong operational discipline.
Understanding operating expenses through an example
Imagine a retail business with monthly operating expenses that include $5,000 for rent, $3,000 for employee wages, $2,000 for utilities, and $1,000 for marketing. These costs, totaling $11,000, are necessary to keep the business running. If the business generates $20,000 in monthly revenue, its operating expenses account for over half of its income, leaving the remainder for other costs like taxes and profits.
In another example, a software company’s operating expenses include salaries for developers, subscription costs for cloud services, and office rent. By analyzing these expenses, the company identifies that it can save money by transitioning to a smaller office space and negotiating lower rates for its cloud services.
An example of an operating expenses clause
Here’s how an operating expenses clause might appear in a contract:
“Operating expenses shall include all costs incurred in the ordinary course of business, including but not limited to salaries, utilities, rent, marketing, and other day-to-day expenditures necessary for the operation of the business. These expenses shall be accounted for in accordance with generally accepted accounting principles (GAAP).”
Conclusion
Operating expenses are a vital part of any business, representing the costs required to maintain daily operations. Managing these expenses efficiently helps improve profitability and ensure the company’s long-term financial health. A clear operating expenses clause in contracts or agreements provides transparency and ensures a shared understanding of how these costs are defined and managed.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.