What are operating expenses?
Operating expenses refer to the costs associated with running a business on a day-to-day basis, such as rent, utilities, salaries, marketing expenses, and other similar expenses. When starting a business, they’re something to potentially build into your business plan.
These expenses are crucial because they impact a company's profitability and sustainability. If expenses are too high, it can affect a company's ability to make a profit or even stay in business. By carefully managing and optimizing operating expenses through their small business accounting and bookkeeping, businesses can increase their chances of success both in the short and long term.
The concept of operating expenses has been around since the advent of commerce. However, it wasn't until the rise of industrialization and the growth of large corporations that operating expenses became a critical aspect of business operations and management strategies.
Key components of operating expenses
The expenses necessary to run and manage a business may include any or all of the following, depending on the type of business and industry:
Costs associated with producing and delivering products or services
General and administrative costs like salaries and office expenses
Sales and marketing costs like advertising and promotions
Research and development costs
Depreciation expenses, accounting for pure risk situations too
Why it's important to understand how to manage operating expenses effectively
Carefully managing businesses expenses can bring the following benefits for a company:
Better control over cash flow
Improved decision-making capabilities based on accurate financial information
Ability to invest in new opportunities or growth areas
Examples of actual operating expenses per business type
Operating expenses can vary according to the type of business, and how it operates. Here are a few examples of different types of businesses with specific examples of expenses unique to them,
Business: Retail store
Expenses: Rent and utilities for their brick and mortar store
Business: Law firm
Expenses: Salaries and office management costs, including rent and utilities but also services for the employees, cleaning staff and other maintenance crew.
Expenses: Marketing costs, for a company needed to build a brand, can be high at first. A startup may be able to reduce money spent on rent by keeping offices small or by working from home, but showcasing a new product or website will require more investment.
Business: Pharmaceutical company
Expenses: Research and development will take up a large chunk of this type of companies operating costs, as it develops new treatments.
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Best practices for managing operating expenses
To optimize expense management, businesses should follow these 5 best practices as a starting point:
01. Regularly review and analyze operating expenses to identify areas for improvement - where can cuts be made, or expenses be used more efficiently.
02. Negotiate with vendors and suppliers to get the best possible prices.
03. Implement cost-saving measures like energy-efficient equipment or remote work policies.
04. Set realistic budgets and track actual expenses against them.
05. Invest in technology that can streamline operations and reduce costs.
Challenges associated with business expense management
Managing business costs can be challenging, especially for a first time or new business owner, for the following reasons:
Manual processes or outdated systems can make tracking operating expenses inefficient and inaccurate.
Overspending is a real risk if budgets are not properly managed.
The potential for unexpected expenses like legal fees or emergency repairs can derail the most carefully of planned budgets and business plans.
The need to balance cost-cutting measures with the need to invest in the business for growth. The two are intricately linked and a need for greater growth without derailing a budget is a huge challenge for all businesses.