How are COGS vs. Operating Expenses Different?
COGS vs. Operating Expenses comes down to how COGS are the direct cost of selling products/services while OpEx is the indirect costs not tied to revenue production.
Part of running a company properly is recording operating costs, which comprises two categories:
- Cost of Goods Sold (COGS)
- Operating Expenses (OpEx)
- What are the definitions of cost of goods sold (COGS) and operating expenses (OpEx)?
- On the income statement, why are COGS and operating expenses separated?
- How are COGS and OpEx different from each other?
- Are capital expenditures related to COGS/OpEx?
COGS vs. Operating Expenses Similarities
COGS and OpEx are both considered “operating costs,” which means that the expenses are related to the company’s core operations.
COGS vs. Operating Differences
Now, let’s move on to discussing the differences between COGS and OpEx.
The cost of goods sold (COGS) line item represents the direct cost of selling products/services to customers.
Examples of costs included in COGS are:
- Purchase of Direct Materials
- Direct Labor
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.
Examples of OpEx that apply to the statement above are:
- Employee Wages
- Rental Expenses
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/Product Research
- Sales & Marketing
The takeaway here is that OpEx is far more than just “keeping the lights on,” contrary to a common misconception.
COGS 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).
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.
COGS vs. Operating Expenses Comparison Conclusion
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.