A company’s chief goal is to bring in revenue by selling products and services. To know how successfully it's doing that, the company needs to carefully analyse the day-to-day costs it incurs to keep operations running.
By carefully tracking operating expenses (OpEx), business leaders can get a clear overview of how cost-effectively the firm is delivering to its customers. In this article, we will look at some examples of OpEx, how it is calculated and why it is important.
Understanding OpEx
OpEx is the sum of all the everyday expenses a business incurs to deliver services or products to its customers.
For example, a coffee shop’s OpEx would include:
- Staff salaries
- The energy it needs to run its espresso machines
- The rent it pays to lease its premises
- Advertising and promotion
- Staff benefits
Managing OpEx
Operating expenses are not fixed, meaning they can be managed to help a company control the overall cost of doing business. Overspending is a drain on profit and companies must monitor what money goes out of their accounts so that they can make changes to the way they operate and maintain their profit margins.
That might mean increasing prices, hiring more staff if the business is growing, or laying off workers if trade slows.
Arbtech is an ecological and arboriculture consultancy business in Cheshire. CEO Robert Oates, says he is rarely informed of “anything alarming” by his finance team, because he has day-to-day visibility over the company’s finances.
“We keep a very close eye on expenditure, and we keep a very, very close eye on sales and gross margins,” says Oates, who employs around 100 people. “Between the two, we get a pretty good idea of whether or not we’ve got expenditure under control.”
Like many companies, Arbtech authorises its staff to spend money on supplies and services necessary to carry out their jobs. Oates said his team, which undertakes environmental surveys, needs to hire sophisticated equipment, make overnight site visits, and pay for general clerical materials.
He manages this by issuing staff members with supplementary American Express® Business Cards, which makes tracking spending easy and allows managers to set spending limits to better control outlays.
Alternatives, such as reimbursing employees for using their own cash or cards, add unnecessary complexity and take control out of the company treasurer’s hands.
“It is not fair for me to expect our team to pay upfront for the costs of working for the company – some senior team members have expenses of thousands of pounds per month,” Oates says.
Examples of OpEx
Travel Expenses
Company employees will often be expected to travel in the course of their work. Sales teams, for instance, may be asked to attend trade shows to promote the company, and purchasing managers may be required to meet suppliers at their offices.
These activities incur costs, usually train and plane tickets, car hire, hotel rooms and meals away from home. These costs are all accounted for under OpEx because they are needed for the delivery of services and products.
Wages and benefits
The wage bills of staff who are directly involved in making products are classified as a cost of sale, but the money paid to staff who help keep the business running is an operating expense. This is usually the largest overhead a company will enter on its OpEx ledger.
If a company offers health insurance or other non-cash benefits to employees these will be included as OpEx.
Each year, Oates chooses to use his Amex® Business Card to reward the company’s hardest worker with a short holiday. “The Card contributes towards creating a company culture that brings value to our customers and our team,” he says.
With an American Express® Business Gold Card for each full and eligible £1 you spend on everyday business purchases, you'll gain 1 Membership Rewards® point¹. You can then use points with hundreds of retailers as employee rewards. Moreover, payment terms of up to 54 days help put more flex in your cash flow management².
How to calculate OpEx
OpEX is calculated by adding together all costs associated with the day-to-day running of the business, from salaries and rent to benefits and utilities.
This may sound simple in theory, but it can be a time-consuming and complex task in practice because it requires the collection and calculation of the receipts of all costs incurred by staff and departments.
“Actually, it is an absolute pain, but a necessary one,” says Oates, whose company asks staff to submit their expenses once a month. “It can be stressful, especially if you are carrying a month’s worth of receipts around. Lose one and it can cause a lot of pain trying to trace that expense.”
Calculating operating profit and OER
Once all the relevant financial information is gathered to give a figure for OpEx, that can then be subtracted from gross income, or sales, to reveal the company's operating profit.
Operating Profit = Sales – Total Operating Costs (OpEx + Cost of Sales)
A measure of how well a company manages its outgoings is the operating expense ratio (OER), which gives a relative guide to how much of its income is accounted for by costs. If the OER lowers over time, that generally means that profitability is improving. Anything below 70% is considered good.
OER = Total Operating Costs / Sales
If our coffee shop spends £10,000 a year on OpEx, £2,000 on beans and other ingredients, and goes on to have sales of £50,000, then it has an operating profit of £38,000 and an OER of 24%.
Operating profit (£50,000 – (£10,000+£2,000) = £38,000)
OER (£12,000/£50,000 = 0.24 or 24%)
OpEx vs CapEx vs COGS
OpEx is one of several types of costs that companies include on their profit and loss statements. The main other category is that of capital expenditure (CapEx), covering things like the initial investment in espresso machines, crockery and furniture for the coffee shop. If a company makes products from raw materials it will also likely use costs of goods sold (COGS), such as the cost of making fresh pastries from scratch.
Knowing how to manage costs and income is important for planning for the future, says Pamela Phillips, Co-Founder and Managing Director of De Jong Phillips, an accountancy firm in the UK.
“If you really understand what you spend and where you are spending it you can critically analyse that and then make better decisions about the business,” says Phillips. “It helps you identify where you are spending way too much and examine what levers you need to pull to improve that to make the business more profitable.”
1. Membership Rewards points are earned on every full eligible £1 spent and charged, per transaction. Terms and conditions apply.
2. The maximum payment period on purchases is 54 calendar days and is obtained only if you spend on the first day of the new statement period and repay the balance in full on the due date. If you'd prefer a Card with no annual fee, rewards or other features, an alternative option is available – the Business Basic Card.
