Small BusinessOperationsAccounting

What are operating expenses?

Ask yourself this: Why would a high-growth tech startup struggle to keep up with mounting rent payments and costly marketing campaigns? Why would a bustling bake shop not be able to turn a profit despite selling out each day?

Welcome to the world of operating expenses. Also called “OpEx,” operating expenses are the ongoing expenses a business incurs from its day-to-day operations — and they can significantly impact a company’s profitability and long-term viability.1

From rent and utilities to employee salaries and office supplies, understanding and effectively managing operating expenses is essential for businesses, big or small. Learn more in this guide.

Understanding operating expenses

Operating expenses are what keep a business up and running. These regular, recurring expenses are necessary for maintaining the essential functions of a business. If they’re not managed correctly, they may cause financial instability and hinder growth.

It’s important to note that operating expenses can cover a range of day-to-day expenditures and often differ between industries. They also exclude costs directly associated with producing goods or services (cost of goods sold) and long-term investments or physical assets (capital expenditures).

What is included in operating expenses?

So what are considered operating expenses? Here’s a general list of operating expenses that many businesses may incur:

  • Salaries and wages: Compensation paid to employees, including regular salaries, wages, and benefits like healthcare, retirement contributions, and paid time off.
  • Rent and utilities: Expenses associated with leasing or owning office, retail, or manufacturing spaces, as well as expenses for utilities like electricity, water, heating, and internet.
  • Office supplies: Materials and supplies needed for daily operations, like paper, pens, coffee, etc.
  • Software and technology: Expenses for software licenses, IT services, and technology upgrades.
  • Insurance: Premiums paid for various types of insurance coverage, such as liability insurance, property insurance, and business interruption insurance.
  • Marketing and advertising: Expenses related to promoting the business, including advertising campaigns, marketing materials, public relations, and digital marketing.
  • Maintenance and repairs: Expenses for maintaining and repairing equipment, machinery, vehicles, and facilities.
  • Professional services: Payments to external consultants, legal advisors, and accountants for specialized services and expertise.
  • Taxes and licenses: Payments for business licenses, permits, and various taxes.
  • Depreciation: The decrease in value or wear-and-tear that an asset experiences as it is used in business operations.
  • Travel: Expenses incurred for business-related travel, accommodations, and client meetings.

Importance of managing operating expenses

When business owners learn how to manage operating expenses, they can work to bolster profitability and sustainability.

Here are some key areas that can be positively impacted when operating expenses are managed effectively:

  • Profitability: Operating expenses can directly impact a company's profitability. While increasing revenue is one way to boost profit, reducing unnecessary expenses can quickly and directly impact a company’s bottom line.
  • Cash flow management: When expenses are controlled, a business can ensure that its cash inflows (revenue) are sufficient to cover its cash outflows (expenses). This is essential for meeting immediate financial obligations, such as paying employees, suppliers, and creditors.
  • Resource allocation: By analyzing and managing expenses, a company can allocate its resources more efficiently, such as reallocating funds from less productive areas to those that drive growth.
  • Growth opportunities: By reducing operating expenses, a company can free up funds to reinvest in the business.
  • Resilience: Businesses with well-managed operating expenses can better navigate challenging times like economic downturns, natural disasters, or supply chain disruptions.
  • Debt management: By keeping operating expenses in check, a company can avoid unnecessary debt and the associated interest payments.
  • Long-term viability: Effective expense management helps prevent excessive spending that could otherwise erode profitability and hinder growth.

Strategies for reducing operating expenses

Looking to cut costs? Once you’ve listed and analyzed your operating expenses, you can better understand where your money is going and identify ways to reduce or eliminate certain expenses.

Here are some quick strategies to help get you started:

  • Review and renegotiate contracts for services like rent, utilities, and insurance to ensure you secure the best rates.
  • Focus on cost-effective marketing strategies, such as digital marketing and social media, to reach your target audience without overspending on traditional advertising that may not yield the same results.
  • Consider outsourcing non-core functions to specialized vendors. Outsourcing tasks like IT support, payroll processing, and customer service may be more cost-effective than handling them in-house.
  • Implement waste reduction strategies to minimize material and resource use. This can include recycling, reusing materials, and optimizing production processes.
  • Invest in technology solutions that can automate tasks, improve efficiency, and reduce labor costs. This can include software for inventory management, customer relationship management (CRM), and accounting.
  • Embrace remote work and flexible scheduling options, which can reduce office space costs and improve employee satisfaction.
  • Negotiate with professionals and suppliers to get better deals. Bulk purchasing or long-term contracts may lead to cost savings.

Remember: It’s important to regularly monitor your progress and adjust your strategies as needed.

Budgeting and forecasting

As you strategize ways to reduce certain operating expenses, consider building a realistic budget and financial forecast to keep your business on track. These tactics can provide a structured approach to planning, allocating resources, and tracking performance.

Plus, budgeting and forecasting can align financial goals with strategic objectives. In other words, ensuring that expenses are directed toward activities that contribute to an organization's success.

Not sure where to start? Several software and tools are available to streamline the tracking and management of operating expenses, with features like budgeting, expense categorization, and reporting. When choosing a tool, consider factors like your business size, budget, desired features, and integration capabilities with your existing systems.

When it comes to setting practical expense targets, best practice is to contact a financial services professional like an accountant or strategic planner to create a tailored approach for your business.

Common mistakes to avoid

Managing operating expenses can be challenging for new and small businesses, as they often encounter common pitfalls that can affect financial stability — from poor cash flow management to unexpected expenses.

To navigate these challenges and make informed decisions, consider the following solutions:

  • Mixing personal and business finances: Maintain clear separation between personal and business expenses by using dedicated accounts and payment methods. Keep detailed records to avoid confusion.
  • Neglecting expense tracking: Use expense tracking tools to record and categorize all expenses accurately. Regular reconciliation can help identify discrepancies.
  • Ignoring small expenses: Pay attention to small, recurring expenses, as they can accumulate over time.
  • Underestimating hidden costs: Factor in hidden costs like maintenance, upgrades, or taxes when estimating expenses.
  • Impulse spending: Consult your budget and evaluate the necessity and long-term value of purchases before making them.
  • Not seeking professional advice: Seek financial advice from experts, as their insights can guide effective expense management and decision-making.

Take control of your business’s operating expenses

Operating expenses are the backbone of a business's day-to-day operations. With a strategic approach and careful attention to detail, businesses can take charge of their operating expenses and pave the way to profitability and success.

Discover more helpful strategies for running a business and explore the benefits of a PayPal Business account.

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