What are operating expenses and how do you calculate them?

Operating expenses are the day-to-day costs that businesses incur to keep their operations running, distinct from the costs directly tied to producing goods or services. These recurring expenses include everything from rent and utilities to employee salaries, marketing campaigns, and technology subscriptions. For companies like Starbucks, operating expenses encompass barista wages and store leases, while tech giants like Microsoft must account for research and development costs alongside their substantial cloud infrastructure maintenance.

Unlike capital expenditures, which represent investments in long-term assets expected to generate value over many years, operating expenses are consumed within the current accounting period. They appear directly on the income statement and impact profitability immediately, making them essential barometers of operational efficiency. When companies successfully trim operating expenses while maintaining service quality, their profit margins can expand despite modest revenue growth — demonstrating how controlling these costs often separates the winners from the losers in competitive markets.

Is inventory an operating expense?

A common point of confusion among business operators concerns the classification of inventory, the products a business purchases with the intention to resell. Unlike rent or salaries, inventory itself is not considered an operating expense when acquired. When a retailer or manufacturer purchases inventory, these items are recorded on the balance sheet as assets rather than being immediately expensed. Only when inventory items are sold do they transition from the balance sheet to the income statement, where they appear as Cost of Goods Sold (COGS), a category distinct from operating expenses.

This accounting treatment reflects an important business reality: inventory represents value the business still holds until the moment of sale. However, many inventory-related activities do generate legitimate operating expenses. The cost of warehousing merchandise, implementing inventory management software, paying staff to handle stock, and insuring goods all qualify as operating expenses that impact the current period’s profitability. This creates a dual financial impact where the physical inventory affects COGS when sold, while the infrastructure to maintain, track, and protect that inventory generates ongoing operating expenses regardless of sales volume. For business leaders, understanding this distinction proves essential when analyzing cost structures and identifying opportunities to enhance operational efficiency.

Operating expenses manifest in numerous forms across businesses, and categorizing them helps leadership make informed financial decisions. Understanding these categories enables business leaders to identify precisely where capital is flowing within their organization, revealing opportunities for strategic optimization and cost control. By breaking down expenses into structured categories, management can prioritize which areas deserve attention and develop targeted approaches to improve profitability without sacrificing operational effectiveness.

Two complementary approaches help organize operating expenses in ways that illuminate different aspects of business spending. The first approach categorizes costs by their fundamental nature, distinguishing between fixed expenses that remain constant regardless of business activity and variable expenses that fluctuate with production or sales volume. The second classification method organizes expenses by functional category, grouping costs according to the business purpose they serve, such as personnel, facilities, marketing, or technology. Both perspectives offer valuable insights for budgeting, financial analysis, and resource allocation decisions.

Fixed operating expenses

Fixed operating expenses remain relatively consistent regardless of business activity, creating a financial baseline that businesses must maintain even during slow periods. These predictable costs include office or retail space leases, property taxes, business insurance premiums, salaried employee compensation, and subscription software services. The consistency of fixed expenses makes them easier to budget for but also means they continue to drain resources even when revenue declines, highlighting the importance of maintaining appropriate fixed cost structures relative to typical business volume.

Variable operating expenses

Variable operating expenses fluctuate in direct proportion to business activity, rising during busy periods and naturally declining when operations slow. These responsive costs typically include hourly labor, shipping and logistics fees, sales commissions, credit card processing charges, and utilities that scale with usage. The elastic nature of variable expenses provides built-in financial flexibility, as these costs naturally adjust to business conditions, though they can become difficult to predict during periods of rapid growth or contraction.

Personnel expenses

Personnel costs typically constitute the largest operating expense category for most service-oriented businesses, encompassing far more than just base compensation. This category includes salaries and wages, payroll taxes, health insurance and retirement benefits, worker compensation insurance, recruitment costs, and employee training and development programs. The substantial investment businesses make in human capital reflects both its critical importance to operations and its potential as an area where thoughtful management can significantly impact overall operating efficiency.

Operating expenses fundamentally shape a business's financial health through their direct impact on profitability. Each dollar an organization saves when they reduce operating expenses flows straight to the bottom line, enhancing profit margins without requiring additional sales efforts. This explains why businesses with similar revenue figures can experience vastly different profit outcomes. Even enterprises with impressive sales volumes may struggle to generate meaningful profits when their operating expenses consume too large a portion of their revenue, underscoring why expense management deserves as much strategic attention as revenue generation.

For small businesses and startups, operating expense management takes on existential importance through its effect on cash flow. Unlike revenue, which may arrive inconsistently or with payment delays, operating expenses demand regular cash outlays for everything from payroll to utility bills. Organizations that minimize unnecessary expenses create vital breathing room in their cash position, providing essential reserves for navigating unexpected challenges or funding growth opportunities without taking on additional debt or diluting ownership through new investment rounds.

Businesses that maintain efficient operations gain valuable flexibility to offer more competitive pricing or to channel additional resources toward innovation and expansion. This operational discipline becomes particularly helpful during economic downturns, when companies with streamlined expense structures can often continue operating profitably while others struggle. Furthermore, regular analysis of operating expenses frequently uncovers operational inefficiencies that, when addressed, can improve overall business performance. Organizations that systematically review their expense patterns often discover redundant services, underutilized resources, or process inefficiencies that, once corrected, deliver benefits beyond mere cost savings by making the entire operation more effective.

Having examined the common pitfalls in expense management, let's turn our attention to establishing effective tracking practices. The difference between financial clarity and chaos often comes down to the consistent application of a few key principles. While every business has unique needs, these five steps provide a foundation for managing operating expenses with confidence and precision.

Step 1: Choose an expense tracking tool

What tools actually make expense tracking easier rather than adding complexity? This question deserves careful consideration as your choice will affect daily operations. Accounting software platforms like QuickBooks, Xero, and FreshBooks offer comprehensive solutions with automated bank feeds, receipt capture, and built-in reporting functions. These digital assistants dramatically reduce manual data entry while providing sophisticated analysis capabilities.

Some smaller operations thrive with simpler solutions. A well-structured Excel or Google Sheets template works effectively when designed with clear categories and consistent formatting. Receipt management applications are another strong option. Products such as Brex transform paper documentation into digital records instantly, eliminating the notorious shoebox method of receipt storage. Whatever route you take, prioritize user friendliness above all else. The perfect tracking solution ultimately becomes the one your team will use faithfully.

Step 2: Establish clear expense categories

Thoughtful categorization transforms individual transactions into meaningful financial intelligence. Without proper organization, it becomes nearly impossible to track payments and analyze business spending effectively. Most companies benefit from standard groupings such as rent and facilities, payroll and benefits, marketing expenditures, office supplies, professional services, travel expenses, and technology costs. Your specific industry might require additional specialized categories.

Finding the right balance is incredibly important. Excessive categories create unnecessary complexity and inconsistent application, while insufficient groupings mask important distinctions needed for decision-making. Consider aligning your internal expense categories with tax reporting requirements whenever possible. This alignment greatly simplifies year-end tax preparation and ensures your regular financial reports directly support compliance requirements. Many business owners discover that careful upfront category planning saves countless hours during tax season and financial reviews.

Step 3: Record expenses regularly

Procrastination is the enemy of accurate financial records. When receipts pile up and transactions go unrecorded for weeks, critical details fade from memory, documentation gets lost, and the inevitable backlog creates stress. What begins as “I’ll catch up this weekend” often becomes a quarterly nightmare of incomplete records and reconstructed transactions.

How frequently should you update your expense records? For most small to medium businesses, at least weekly processing strikes the right balance between timeliness and efficiency. Modern tools make this easier than ever — mobile apps capture receipts instantly, and automated bank feeds pull transactions directly into your accounting software. The satisfaction of maintaining current financial records extends beyond peace of mind; it enables responsive decision-making based on current information rather than outdated snapshots.

Step 4: Reconcile monthly with bank statements

Monthly reconciliation serves as your financial reality check. Reconciling bank statements through this verification process compares recorded transactions against actual money movement through your accounts, revealing discrepancies before they become permanent problems. When your credit card statement shows an unfamiliar charge, reconciliation prompts investigation before incorrect data infiltrates your financial reports.

Many accounting tools now automate much of this process through bank feeds and matching algorithms, but human oversight remains essential. Beyond catching accounting errors, monthly reconciliation creates a natural checkpoint for reviewing unusual expenses, identifying forgotten subscriptions, and spotting potential fraud. Think of it as a monthly financial wellness check — sometimes routine, occasionally revealing surprising insights about your business's financial health.

Step 5: Review reports and monitor spending

What stories do your operating expenses tell about your business? Regular financial analysis converts raw numbers into actionable intelligence. Monthly income statements highlight overall performance trends, while detailed expense reporting reveals specific opportunities for improvement. Perhaps marketing spending increased without corresponding revenue growth, or technology costs gradually expanded through accumulated subscriptions. Such patterns emerge only through deliberate review.

Effective financial analysis combines both comprehensive overview and targeted investigation. Begin by examining broad metrics such as your operating expense ratio, then investigate specific categories showing unusual patterns. Many business owners find dedicated monthly review sessions valuable for maintaining financial awareness. Schedule these reviews when you can approach the information with a fresh perspective rather than rushing through reports at month's end amid other closing tasks.

Commingled finances create unnecessary complications. Maintaining separate business accounts and credit cards establishes clear financial boundaries that simplify tracking, strengthen legal protections, and prevent mistakes. No financial practice delivers more value with less effort than proper separation between personal and business finances. If you haven't established dedicated business accounts yet, consider this your priority action item for improved expense management.

Fixed operating costs represent the financial commitments a business maintains regardless of its activity levels or revenue generation. These expenses persist month after month in consistent amounts, creating a baseline financial obligation businesses must satisfy even during periods of reduced operations. Common fixed expenses include office or retail lease payments, salaried employee compensation, business insurance premiums, subscription software services, and property taxes. Despite their name, fixed costs are not permanently unchangeable; businesses can renegotiate contracts, relocate to less expensive facilities, or restructure operations to reduce these expenses. However, the defining characteristic remains that these costs do not automatically fluctuate with short-term changes in business volume or output.

Variable operating costs, by contrast, rise and fall in direct proportion to business activity, creating a natural financial adjustment mechanism as operations expand or contract. These responsive expenses include hourly wages, utility bills that increase with extended operating hours, shipping and packaging materials that grow with higher sales volume, and sales commissions that increase as revenue climbs. The inherent elasticity of variable expenses provides businesses with built-in financial flexibility, as these costs naturally decrease during slower periods and increase during busier ones, helping to preserve profitability across different operating conditions without requiring management intervention.

Many real-world expenses exhibit characteristics of both fixed and variable costs, creating what financial analysts call semi-variable or mixed expenses. These hybrid costs contain a baseline fixed component that exists regardless of business activity, plus a variable element that increases with usage or output. Common examples include telecommunication plans with fixed monthly charges plus usage-based overage fees, utilities with base connection charges plus consumption rates, and compensation structures featuring both base salaries and performance bonuses. Understanding these nuanced cost behaviors allows businesses to more accurately predict how expenses will respond to changing business conditions.

The practical value of distinguishing between fixed and variable expenses extends beyond accounting classifications into strategic business management. Fixed expenses create financial stability but also pressure, as they represent obligations a business must meet regardless of revenue. Businesses with high fixed costs require greater sales volume to break even but can achieve stronger profitability once that threshold is crossed. Conversely, operations with predominantly variable costs offer greater financial flexibility and lower risk during downturns, though they may capture less profit during booms. This knowledge proves particularly valuable when forecasting profitability across different scenarios, identifying cost control opportunities, and making structural business decisions about resource allocation.

Non-operating expenses represent costs incurred outside the scope of a business's core operations, creating a distinct financial category that requires separate analysis and management approaches. Unlike operating expenses that fund the everyday activities generating revenue, non-operating expenses typically arise from financing activities, extraordinary events, or peripheral business concerns. Common examples include interest payments on business loans, losses incurred when selling company assets, foreign currency exchange losses, litigation settlements, restructuring charges, and even income tax obligations. These costs, while potentially substantial, do not directly contribute to producing goods or delivering services that constitute the organization's primary value proposition.

Financial statements deliberately separate operating from non-operating expenses to provide clearer insights into business performance. On income statements, non-operating expenses appear below the operating profit line, allowing analysts and managers to first evaluate how efficiently the core business functions before considering these additional financial impacts. This structural separation proves critical when assessing operational efficiency, as it prevents peripheral financial activities from obscuring the fundamental question of whether the core business model generates adequate profitability. When investors and lenders evaluate business health, they often focus intensely on operating metrics before factoring in these supplementary costs, recognizing that a strong operational foundation ultimately determines long-term viability.

The distinction between operating and non-operating expenses carries significant practical implications for business management strategies. Addressing elevated operating expenses typically involves operational improvements like process optimization, vendor negotiations, or technology investments that enhance efficiency. Conversely, managing non-operating expenses often requires entirely different approaches focused on financial engineering, such as debt refinancing to reduce interest obligations, timing asset sales more advantageously, or establishing more robust legal compliance procedures to avoid litigation costs. This categorical separation allows business leaders to deploy specialized tactics appropriate to each expense type rather than applying generic cost-cutting measures across dissimilar financial challenges.

Financial analysis that carefully distinguishes between operating and non-operating expenses enables more nuanced business decisions by clarifying which aspects of performance fall within management's direct operational control. A business showing strong operating profits but struggling with overall profitability due to heavy interest burdens requires financing adjustments rather than operational cutbacks that might undermine its successful core activities. Similarly, occasional non-operating charges like restructuring costs should not trigger panic about the fundamental business model if operating metrics remain healthy. This analytical clarity helps prevent misdiagnosis of financial challenges and ensures that remedial actions target the actual sources of financial stress rather than disrupting functional business operations unnecessarily.

The terms “overhead” and “operating expenses” frequently appear interchangeably in business discussions, but they maintain a subtle yet important distinction in precise financial analysis. Overhead refers specifically to ongoing business expenses that cannot be directly attributed to creating a particular product or delivering a specific service. These indirect costs typically include facility expenses like rent and utilities, administrative staff salaries, insurance premiums, and general office supplies. What characterizes true overhead is its disconnect from production volume — these costs persist whether a business produces one unit or one thousand. In financial terms, overhead costs represent a subset of the broader operating expense category, generally comprising the fixed costs essential for maintaining basic business functions.

While operating expenses encompass all costs associated with running a business day to day, overhead focuses specifically on the foundational costs required simply to keep operations viable. This distinction becomes clearer when considering discretionary operating expenses like marketing campaigns, research initiatives, or employee training programs. These expenditures, while classified as operating expenses, extend beyond basic overhead because management can adjust or temporarily suspend them without immediately jeopardizing core business functions. Financial analysts and business owners benefit from recognizing this nuance, as it allows for more targeted cost management strategies. During financial constraints, discretionary operating expenses often present more immediate opportunities for reduction compared to essential overhead costs, which typically require more structural business changes to meaningfully address.

Calculating total operating expenses follows a straightforward additive approach, wherein businesses sum all individual expense line items associated with day-to-day operations for the relevant period. These typically include salaries and wages, rent and facilities costs, utilities, office supplies, marketing and advertising expenditures, insurance premiums, and professional services fees. Most modern accounting software automatically aggregates these expenses, though businesses maintaining manual records can derive the same figure by tallying all non-COGS expenses incurred during normal operations. This comprehensive sum provides the foundation for several critical financial metrics that guide managerial decision-making beyond simply knowing how much was spent.

The Operating Expense Ratio (OER) stands as a particularly useful efficiency metric, calculated by dividing total operating expenses by revenue and multiplying by 100 to yield a percentage. This ratio reveals what portion of each revenue dollar goes toward funding operational activities rather than contributing to profit. A retail business generating $500,000 in annual revenue while incurring $150,000 in operating expenses would have an OER of 30%, indicating that nearly one-third of every sales dollar supports operational functions. Generally, lower OERs signal greater operational efficiency, though optimal values vary substantially across industries based on their inherent cost structures. Service businesses frequently maintain higher OERs than software companies, reflecting their greater reliance on labor and physical infrastructure relative to revenue generation.

Operating income, also known as operating profit or earnings before interest and taxes (EBIT), quantifies the financial performance of core business activities by subtracting operating expenses from gross profit. This calculation follows a simple formula: Revenue minus Cost of Goods Sold minus Operating Expenses equals Operating Income. For example, a business recording quarterly revenue of $100,000 with $40,000 in cost of goods sold and $30,000 in operating expenses would achieve gross profit of $60,000 and operating income of $30,000. The corresponding operating profit margin of 30% indicates that the business retains 30 cents of each revenue dollar after covering both direct production costs and operational expenses, but before addressing financing costs and tax obligations. This metric provides a clearer picture of operational performance than gross margin alone, as it accounts for the full spectrum of expenses required to maintain business functionality.

Regular monitoring of these operating expense calculations yields actionable insights that enhance financial management across multiple time horizons. Monthly or quarterly tracking reveals whether operating expenses are growing proportionally with revenue or accelerating at a concerning rate that might compress future profitability. When implementing cost control initiatives, these metrics provide quantifiable evidence of progress, allowing management to determine whether reduction efforts are yielding meaningful financial improvements. Additionally, historical operating expense patterns serve as the foundation for creating realistic forward-looking budgets and financial projections. By understanding both the absolute value and relative proportion of operating expenses, business leaders can make more informed strategic decisions about resource allocation, pricing strategies, and expansion opportunities.

The main difference between operating expenses and capital expenditures comes down to timing and how long the business benefits from the purchase. Operating expenses are regular, everyday costs that keep your business running, with benefits used up within the current year. Capital expenditures are investments in assets that provide value for multiple years. This becomes clearer with examples. Buying printer paper counts as an operating expense because you go through it quickly in daily operations. Buying the printer itself is a capital expenditure because it will serve your business for years. Monthly software subscriptions are operating expenses, while purchasing software you'll own forever is typically a capital investment because of its long-term value.

Repairs versus replacements offer another way to tell the difference. Regular maintenance that keeps equipment working as expected without extending its useful life counts as an operating expense. However, completely replacing equipment or making major improvements that significantly extend its life or add new features typically counts as a capital expenditure. A good rule of thumb is to consider the time period. If the main benefit of what you're buying will last beyond the current year, it's probably a capital expenditure. This applies to purchases like vehicles, furniture, and technology. When you're unsure about how to classify an expense, it's best to check with an accountant. Getting it wrong can distort your financial statements and potentially cause tax problems, especially as your business grows and your expenses become more complex.

Now that you understand what operating expenses are and how to track them, let's focus on practical ways to manage and reduce these costs. Small changes in how you handle expenses can improve cash flow and lead to big improvements in your bottom line. Here are five proven strategies that can help any business spend smarter and move faster.

Create and stick to an operating budget

A detailed budget gives your business a financial roadmap for spending throughout the year. Start by creating a plan that shows expected expenses by month and by category, using last year's spending to set realistic targets. Adjust for any growth or changes you expect in the coming months. The real power comes from checking your actual spending against this plan at least once a month. This practice quickly shows where you might be overspending so you can fix problems before they grow. Many business owners say this regular comparison between planned and actual expenses is their most valuable financial habit.

Regularly review and audit expenses

Set aside time each month or quarter to go through your expenses line by line with a critical eye. During these reviews, question every expense by asking if it still makes sense for your business and if it gives enough value for what you pay. Look for wasteful spending that can be cut without hurting your business, such as unused software, forgotten subscriptions, or services you no longer need. Consider starting fresh with each expense rather than automatically approving it because you paid it last year. This approach often reveals costs that exist out of habit rather than necessity, and many businesses find they can easily cut 5-10% from their operating costs this way. Consider updating your expense policy based on these regular audits to formalize your cost-saving measures.

Leverage technology and automation

Smart technology investments can actually save money by making your business more efficient. Look for solutions that can handle repetitive tasks or improve how your team works, saving you money by reducing labor time and mistakes. Project management software, time-tracking tools, and inventory management programs can help avoid wasting resources and improve productivity. Many businesses also find that going paperless with digital documents saves on supplies, storage, and admin time. Even basic accounting software can pay for itself by helping you spot financial issues faster and making tax preparation easier.

Negotiate with vendors and shop around

Many business owners accept whatever price they're first quoted, but most operating costs can be negotiated. For major suppliers or service providers like internet, phone, software, or inventory suppliers, always ask for better rates. Vendors often offer discounts for loyalty, early payment, or buying in bulk, but usually only if you ask. Get multiple quotes for significant expenses like insurance policies, cleaning services, and other regular contracts. This ensures you're getting fair pricing and gives you leverage with current providers. Even if you like your existing vendor, checking market rates once a year can help you negotiate better terms. Many businesses have cut 15-20% of their expenses simply by becoming more active in vendor negotiations.

Optimize office space and utilities

For many businesses, office space is one of their largest expenses. Take a careful look at your current space needs and consider whether you could sublease unused areas or downsize when your lease ends. The growth of remote work has created new ways to reduce space while keeping productivity high, with many companies using hybrid schedules that need less office space. Energy costs also add up quickly, but simple changes make a big difference. Switching to LED lighting, using programmable thermostats, and turning off equipment after hours can significantly lower utility bills. Check with your utility companies about business energy programs or rebates that might offer additional savings. Some businesses have cut utility expenses by 30% or more through these simple changes.

Operating expenses are entirely manageable with the right approach. While these expenditures cannot be eliminated, they can be optimized and controlled through vigilant oversight and strategic decision-making, creating a powerful competitive advantage for disciplined organizations.

The financial impact of expense management compounds dramatically over time, with even modest savings accumulating into substantial amounts across months and years of operation. These incremental improvements frequently separate thriving businesses from struggling ones, particularly in industries with tight profit margins. We encourage you to set aside time this week to review your current operating expenses with fresh eyes, examining spending patterns and identifying potential inefficiencies that could be addressed immediately.

At Brex, we've built our financial platform specifically to address the operating expense challenges businesses face daily. Our integrated solution combines powerful spend management software that provides unprecedented visibility into your expenditures, accounting automation that eliminates tedious manual work, corporate cards with built in controls and rewards tailored to business needs, and intuitive expense management features that streamline the entire process from purchase to expense reconciliation. The result is not just cost savings but valuable time reclaimed for strategic business activities, with clients typically reporting both immediate efficiency gains and long term financial improvements after implementation.

Teddy Collins, Vice President of Corporate Finance at SeatGeek, appreciates how much Brex helps the online ticket marketplace keep its operating expenses in check: “Brex is helping us control our expenses, as well as be more efficient with our No. 1 resource: our employees.” Rafa Tihanyi, Sr. Director of Operations at Graphite, adds: “As a fully remote team with people all over the US and the world, being able to easily track expenses, approve reimbursements, and create virtual cards has been a game changer for our operations team.”

Sign up for Brex today and transform how your business manages operating expenses for greater financial control and improved profitability.