The Importance of an Operating Expenses Formula
Define Operating Expenses Formula
Operating expenses or operating costs refer to the expenses a business will incur through regular operations. In other words, these operating expenses are necessary for the continued performance of activities the business is pursuing.
Operating expenses are an essential metric used when overseeing the performance of a company. The operating expenses formula is used to gather data for both internal and external analysis to better understand how business operating is being handled. Once the primary costs are assessed, strategies to affectively manage operating profit can be implemented.
Some basic categories where operating expenses are found-
- Selling General and General Administrative- Any cost that comes from administering a sale. Includes marketing, advertising, consumer research and promotional materials.
- Cost of Goods Sold- These are the operating expenses from the production of goods and supply chain. Costs can include payroll for assembly employees or equipment repair.
- Management Cost- Expense directly related to payroll costs, bonus pay and benefits for management employees.
- Additional Operating Expenses- Operating expenses that can't be categorized include items like office supplies or vendor fees.
Importance of Operating Expenses
The importance of calculating operating expenses through a standard formula comes back to efficiency. Once the operating expense formula has been used it will highlight the cost level where a company needs to reach in order to generate revenue.
The disadvantage of the operating expenses formula is that it falls within a ratio. Because of this reason, comparisons between firms aren't always accurate even if they're in the same industry. However, the formula can reflect a horizontal analysis within the company that shows performance measures.
What Is The Operating Expenses Formula
The operating expenses formula is a simple matter of adding together all operating expense. A standard formula might include-
- Accounting supplies
- Office supplies
- Legal fees
- Equipment repair
- Marketing and advertising budget
Non-operating expenses are any costs incurred by a business that aren't an essential part of daily operations. Interest, amortization and depreciation are examples of non-operating expenses.
Any large, one-off purchase is considered a capital expense. These types of expenses aren't included in the operating expense formula for reasons relating to the IRS.
Examples of capital expenses are along the lines of acquiring a building space or new equipment purchases. Maintaining said building or equipment would fall under recurring expenses so those would be included in the operating expenses formula.
Operating Expenses in Calculating Operating Expense Ratio
The operating expense ratio, or OER, is used for real estate investors when deciding on whether to invest in a property. This formula is used to calculate the operating expense of said building.
This formula is done the same way as the operating expenses formula. Once the operational costs are added the sum is then divided by gross operating income.
The formula looks like this- OER = (Operating Expenses - Depreciation) / Gross Revenue
Operating Expenses in Income Statements and Reporting
A basic operating expense formula calculations are found in company income statements. The income statement has data which reports the financial activity of a company within a certain time frame. These statements are run per month, but can also be done quarterly or annually. The income statement will address any revenue gains or losses.
Operating Expenses to Calculate Net Profit
When a business calculate their net profit, the chief aim is to analyze the financial performance. Understanding these calculations is helpful when setting profit margins.
The net profit formula looks like this-
Net Profit = Operating Profit Taxes Interest
To calculate operating profit, takes an understanding of breaking down the formula. It looks like this-
Operating Profit = (Revenues Cost of Goods Sold Other Operating Expenses Depreciation & Amortization).
All of these formulas have their place within long term successful business operations.
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Conclusion to Operating Expenses Formula
- Operating expenses are important to analyzing the operational performance of a company to assess management efficiency.
- To calculate operating expense, all operating costs are added together in a standard formula.