Operating expenses are classified into two categories: selling expenses and cost of goods sold.

Selling expenses are the costs associated with distributing, marketing and selling a product or service. They are one of three kinds of expense that make up a company’s operating expenses. The others are administration and general expenses.

Selling expenses can include:

• Distribution costs such as logistics, shipping and insurance costs
• Marketing costs such as advertising, website maintenance and spending on social media
• Selling costs such as wages, commissions and out-of-pocket expenses

Selling expenses are categorized as indirect expenses on a company’s income statement because they do not contribute directly to the making of a product or delivery of a service. Some components can change as sales volumes increase or decrease, while others remain stable. Hence, selling expenses are considered to be semi-variable costs (as opposed to fixed or variable costs).

More about selling expenses

The excerpt below shows where selling expenses appear on a company’s income statement and how they are used to calculate total costs and earnings before interest and taxes.

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Companies incur and record costs in running the day-to-day operations of the business. These costs are separated into two categories—Cost of Sales and Operating Expenses. Cost of sales may also be called cost of services and cost of goods sold. Operating expenses are also known and SG&A—sales, general and administrative expenses. Companies also have non-operating costs that do not belong in these two categories. If your company buys fixed assets or buys another company, those are investing costs. If you pay back a loan, the principle amount is a financing cost; only the interest is an operating cost. Paying dividends to shareholders is a financing cost. Our focus is the operating costs of the business.

What is the difference between cost of sales and operating expenses?

Cost of sales or cost of goods sold represent the costs involved in making and delivering your company’s product or service to a customer. For example, if you make and sell a physical product, the raw materials, labor (including benefits to factory workers), factory costs like utilities and equipment, factory management overhead, shipping costs, etc. are included in cost of goods. For a service company, the salaries of the service providers and any other cost associated directly with providing the service is a cost of sales.

Operating or SG&A expenses can be considered as the overhead to run the company. Think of these as the ongoing costs just to be in business. These are costs for marketing, sales, information technology, human resources, accounting, legal and administrative. These functions are very important, but the people in these departments perform a support function in the business. They are not directly involved in making your product or service. Their services are not what your customer is buying.

Why are cost of sales and operating expenses separated?

These costs are separated for management and analysis purposes. Your company makes money by selling its product or service. Separating these costs allows a company to understand what it is costing to produce and deliver its products or services. Knowing these costs helps determine what those products need to be sold for to make enough ‘gross profit’ on each sale to cover the company’s operating expenses and leave a sufficient ‘net profit.’

Separating the costs makes it easier to see where the problems are if net profit is too low. Managers can look at the data to answer 1) are we not selling enough; 2) are we not charging enough; 3) is it costing too much to make the product; or 4) is our overhead too high?

For owners of small to medium sized companies, the more your company grows, the further removed you are from day-to-day operations. Having your costs properly allocated is essential so that you can understand what is going on in the business. Especially if profit is too low, the cost separation will allow you to see where the problem is occurring.

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An operating expense is an expense that is related to a business’s core operations. Operating expenses (OPEX) are the first expenses shown on a company’s profit and loss statement. The amount left over after operating expenses have been deducted from gross revenue is known as operating income.

Examples of operating expenses

Operating expenses can generally be split into four broad categories. These are:

• Overhead costs

• Cost of goods sold (products)

• Cost of revenue (services)

• Selling, general and administrative expenses

The term overhead costs refers to the fixed operating costs businesses must pay regardless of their output. These are generally much the same for all companies. They include:

• Rent/mortgage

• Utilities

• Certain types of insurance

• Core labor costs (contracted, permanent employees)

The terms cost of goods sold and cost of revenue refer to the operating costs that are directly connected to the production of goods or services. These would typically include:

• Equipment and supplies

• Non-core labor (such as fixed-term employees and freelancers and/or overtime pay for employees)

• Additional insurance (to cover increased production)

• Selling, general and administrative expenses

This can include anything from sales, advertising and marketing to distribution costs to research and development. Many selling, general & administrative expenses are also overhead costs.

Operating expenses vs non-operating expenses

Non-operating expenses are expenses that do not relate directly to the business’s core operations. The most common examples of non-operating expenses are interest, taxes, depreciation and amortization. Less common non-operating expenses can also include inventory write-offs, restructuring costs and even settlements for lawsuits.

Operating expenses in accounting

In accounting, a company’s gross profit is shown as the first line item on the profit and loss statement. Its operating expenses are shown immediately after this. Deducting the operating expenses from the gross income gives the operating income.

Non-operating expenses are shown next. Once these costs have been deducted, from the company’s operating income the money left over is the company’s net income or net profit.

The net profit can be used to calculate the net profit margin. The calculation for this is:

Net Profit/Total Revenue = Net Profit Margin

The significance of operating expenses

In the real world, there are two important facets to managing operating expenses successfully. The first is knowing when to spend and when to save. The second is knowing how to spend.

Spending vs saving

Businesses that compete purely on price may benefit from paring back costs to an absolute minimum. Most businesses, however, compete on value for money. This means they need to keep their costs as low as they reasonably can without compromising on quality.

There are two main strategies businesses commonly use to achieve this.

Firstly, they look to get maximum value out of every purchase they make. This means thinking carefully about what they need and want and looking for the most cost-effective way to get it.

Businesses will generally try to make themselves valuable customers to their suppliers. For example, they will usually try to make fewer, larger orders to benefit from volume pricing. They may order well in advance and possibly make a down payment to secure their goods (or services).

Secondly, they always look for more efficient ways to do what they do. For example, businesses are increasingly using technology to reduce their payroll costs without compromising performance.

Knowing how to spend

For many businesses, the desire to achieve maximum value for money on each purchase has to be balanced against the need to maintain reliable cash flow. This can mean that companies make smaller purchases even though they know that buying in volume would be more economical.

Alternatively, they may avoid buying items and lease or rent them instead. This can work out more expensive in the long run. The additional expense can, however, often be justified by the extra flexibility, improved cash flow and ability to keep cash in hand on the balance sheet.

Which are the two classifications of operating expenses?

What are the 3 common categories of operating expenses?

What are the classifications for types of expenses?

Is selling cost an operating expense?