Operating Costs or Operational Costs, are the expenses which are related to the operation of a business, or to the operation of a device, component, piece of equipment or facility. They are the cost of resources used by an organization just to maintain its existence.
Saying that the operating cost consists of the funds required to perform day-to-day operations doesn't fully differentiate these costs from other business expenses. When thinking about operating costs, think about what it takes to keep the lights on in the office or warehouse. These types of costs include lease and rent payments, utility costs, office supplies, employee wages and bank charges, at the very least. There may also be accounting fees or legal fees included in these numbers, as well as entertainment costs, travel expenses, and sales and marketing costs. Businesses should have these expenses categorized in bookkeeping systems, so that they can easily run reports and financial statements. Operating costs also include the costs of buying or making your products and services. These are often called the cost of goods sold (COGS). These are the costs that are subtracted from total revenues to generate the gross revenue numbers. Operating expenses are then subtracted from this, with taxes and interest on loans to determine the net profit of the company. It may seem like operating costs and operating expenses should mean the same thing, but they don't. The operating expenses refer to the specific costs after gross revenue is defined in the income statement. These include the rent, sales and marketing costs, administrative costs, payroll and office expenses. Simply put, expenses are part of overall costs. Costs include expenses, plus COGS. Failing to understand this distinction could lead to misreading reports and not having a true picture of your company's financial health.
Types of Operating Costs
Operating costs include the cost of goods sold (COGS) and operating expenses (OPEX). They also include depreciation and amortization. Operating costs don’t include interest expenses (from debt service, for example) or taxes (on income or property, for example). They also don’t include startup costs or capital expenses, such as the cost of buying a new building or equipment. Operating costs consist of three types of costs:
- Fixed costs. Fixed costs are those that do not change as sales rise or fall. They do not reflect the productivity of a company, and a company must continue to pay them irrespective of its performance. Such costs include overhead, administrative expenses, insurance, security, and equipment, among other things.
- Variable costs. Variable costs are those that change as a company's sales and production rise or fall. They include such line items as the cost of raw materials, production payroll, and electricity. As production increases, a company must buy more raw materials, hire more production personnel or use more electricity, incurring higher costs.
- Semi-variable costs. There is a third category of costs: Semi-variable costs, also known as a semi-fixed or mixed costs. Such costs may resemble fixed costs at or below a particular level of sales or production, but change as sales or production rise above that level. An example is overtime wages: Below a certain level of production, overtime is non-existent and fixed; above that level, it becomes variable and rises or falls as production does.
Operating Costs Components
While operating costs generally do not include capital outlays, they can include many components of operating expenses including:
- Accounting and legal fees
- Bank charges
- Sales and marketing costs
- Travel expenses
- Entertainment costs
- Non-capitalized research and development expenses
- Office supply costs
- Repair and maintenance costs
- Utility expenses
- Salary and wage expenses