In plain English
Rent, software, insurance, advertising and office costs are typical.
Subtracting them from gross profit gives operating income.
Why it matters
Operating expenses are the costs you pay whether or not you sell anything this month. They set your break-even point. If rent, software and insurance creep up while sales stay flat, profit shrinks without any single bill looking alarming.
Separating these costs from cost of goods sold also matters for pricing. Mixing them makes gross margin look worse and can push you to raise prices for the wrong reason.
Worked example
Gross profit $80,000 minus operating expenses $56,000 is operating income of $24,000.
How to handle it
- Group operating expense accounts into a handful of clear categories, such as occupancy, people, marketing and admin.
- Make sure costs tied directly to a product or job go to cost of goods sold instead.
- Run a twelve-month trend report on operating expenses and look for steady climbs.
- Review recurring subscriptions every quarter and cancel anything no longer used.
Common mistakes
- Putting job materials or subcontractor costs into general expenses, which inflates gross margin and hides job losses.
- Creating a new expense account for every vendor, which makes the report too long to read.
- Recording equipment purchases as office expense when they should be capitalized, which distorts both profit and assets.
Not the same as: Cost of goods sold (COGS)
Cost of goods sold changes with each sale because it is the direct cost of what you sold. Operating expenses are the overhead of keeping the doors open and mostly stay put when sales rise or fall. See Cost of goods sold (COGS).
Go deeper
- Expense Categorization Rules of Thumb: Practical rules for categorizing business expenses consistently: how to choose categories, handle gray areas and keep tax time simple.
Try it
Related terms
- Owner's draw: Money a sole proprietor or partner takes out of the business for personal use.
- Payroll liabilities: Amounts withheld from pay or owed by the employer that have not yet been remitted.
- Net margin: Net income as a percentage of revenue.
Common questions
What are operating expenses?
The regular costs of running a business that are not part of cost of goods sold.
Can you give an example of operating expenses?
Gross profit $80,000 minus operating expenses $56,000 is operating income of $24,000.
Is owner salary an operating expense?
In a corporation that runs payroll, wages paid to an owner employee are generally an operating expense. A sole proprietor's draws are not; they reduce equity instead.
Are interest and taxes operating expenses?
They are usually shown below operating income as other expenses. That keeps the operating line focused on the day to day cost of running the business.
General information, not tax, legal or accounting advice. Confirm rules with the IRS, the NJ Division of Taxation or a licensed professional.