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COGS vs. Operating Expenses

Guide to Understanding Cost of Goods Sold (COGS) vs. Operating Expenses

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COGS vs. Operating Expenses

Cost of Goods Sold vs. Operating Expenses: Similarities

Our post on “Cost of Goods Sold vs. Operating Expenses” will focus on the differences between the two types of costs, but we’ll start with the similarities.

So part of running a company properly is recording operating costs, which comprises two categories:

  1. Cost of Goods Sold (COGS)
  2. Operating Expenses (OpEx)

COGS and operating expenses (OpEx) each represent costs incurred by the daily operations of a business.

COGS and OpEx are both considered “operating costs,” which means that the expenses are related to the company’s core operations.

In addition, the two are linked – i.e. operating income (EBIT) is the gross profit minus OpEx.

Learn More → Cost of Goods Sold Definition (IRS)

Cost of Goods Sold vs. Operating Expenses: Key Differences

Now, let’s move on to discussing the differences between COGS and OpEx.

  • COGS: The cost of goods sold (COGS) line item represents the direct cost of selling products/services to customers. Some common examples of costs included in COGS are the purchase of direct materials and direct labor.
  • Operating Expenses: OpEx, on the other hand, refer to the costs related to the core operations but are NOT directly tied to revenue production. For an item to be considered an operating expense, it must be an ongoing cost to the business. Without a doubt, spending on COGS is important to meet customers’ demand and remain competitive in the market, but OpEx is just as important as a company quite literally cannot continue running without spending on these items. Some common examples of OpEx are employee wages, rental expenses, and insurance.

Contrary to a common misconception, operating expenses do not solely consist of overhead costs, as others can help drive growth, develop a competitive advantage, and more.

Further examples of other types of OpEx are:

  • Research & Development (R&D)
  • Market and Product Research
  • Sales and Marketing (S&M)

The takeaway here is that operating expenses are far more than just “keeping the lights on”.

Cost of Goods Sold vs. Operating Expenses vs. Capex

It is important to note that OpEx represents required spending and is considered one of the “reinvestment” outflows, with the other being capital expenditures (Capex).

That brings us to another topic – how is CapEx related to COGS and OpEx?

Both COGS and OpEx appear on the income statement, but the cash impact of CapEx does not.

Under the matching principle of accounting, the expense must be recognized in the same period as when the benefit (i.e. revenue) is earned.

The difference lies in the useful life, as it can take several years to derive the benefits from CapEx/fixed assets (e.g. purchase of machinery).

Depreciation Expense

To align the cash outflow with the revenue, CapEx is expensed on the income statement through depreciation – a non-cash expense embedded within either COGS or OpEx.

Depreciation is calculated as the CapEx amount divided by the useful life assumption – the number of years that the PP&E will provide monetary benefits – which effectively “spreads” the cost out more evenly over time.

The Bottom Line: COGS vs. Operating Expenses

At first glance, COGS vs. operating expenses (OpEx) might appear virtually identical with minor differences, but each provides distinct insights into the operations of a company.

  • COGS shows how profitable a product is and if changes are necessary, like price increases or attempting to lower supplier costs.
  • OpEx, in contrast, is more about how efficiently the business is being run – in addition to “long-term” investments (i.e. R&D can be argued to provide benefits for 1+ years).

In conclusion, COGS and OpEx are separated for specific purposes in accrual accounting, which can help business owners set prices appropriately and investors better evaluate the company’s cost structure.

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