What are Operating Costs?
Operating costs are the necessary expenditures that you must make to run your business. For example, operating costs may include rent, bank charges, salaries, direct material costs, travel expenses and many other expenses. Operating costs include cost of goods sold (COGS) and operating expenses (OPEX, which are also called selling, general and administrative (SG&A) expenses). Operating costs are recorded on a business’s income statement.
As a business owner, you should keep in mind that there’s an inverse relationship between your operating costs and your net profit. The higher your operating costs, the lower your net profit. So with this in mind, you should be able to make appropriate business decisions as you move forward.
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Operating Cost – Example
For example, let’s say that you have a bakery. Over the last year you sold $55,000 worth of product (i.e. cost of goods sold). During that same time period your operating expenses were $15,250. To calculate your total operating costs, you can use this formula:
Operating Costs = Costs of Goods Sold + Operating Expenses.
For your bakery business, you will add your $55,000 sales and your $15,250 in operating expenses, to get a total of $70,250 in operating costs for the year.
Examples of expenses you make that fall under the operating cost category may include:
- Maintenance costs
- Bank charges
- Travel expenses
- Direct material costs
- Utility costs
Overhead costs are expenditures not directly related to the profit-making aspect of the business; whereas, operating costs are tied to profit generation.
An overhead cost example for your bakery business will be your shop’s furniture fittings. You need to buy this to improve the aesthetics of your business and make your customers comfortable, but you don’t need this expense to produce your pastries and make a profit.
Learn more about Overhead by clicking on this link.
Variable cost is a component of operating cost. It includes expenses that increase or decrease with the level of production.
Let’s say it takes you one bag of flour to produce 100 cakes, and now the holidays are here, there are more orders. You will need three bags of flour to produce 300 cakes; your variable cost is the amount you spent to purchase the flour.
If you’d like to go even deeper and answer the question ‘Why Should A Business Owner Understand Their Gross Margin?’ then click on this link.
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