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Operating Expenses

Understand the Concept of Operating Expenses

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Operating Expenses

In This Article
  • What is an operating expense?
  • What are some common examples of operating expenses?
  • In what ways are operating expenses different from cost of goods sold (COGS)?
  • How is an operating expense different from a non-operating expense?

How to Calculate Operating Expenses

To reiterate, operating expenses (OpEx) are associated with the core operations of a company but do not directly contribute to the production of the product/service sold.

Unique to operating expenses, the majority of costs classified as OpEx are fixed costs, which means they are NOT directly linked to revenue. Instead, OpEx remains relatively constant regardless of production volume.

For example, the rent expense for an office is stated on the contract with the building landlord and does not fluctuate based on revenue performance.

Note that not all operating expenses are fixed costs, as an item like office supplies can be viewed as more of a variable cost since more purchases would be made if production levels were higher.

Examples of Operating Expenses

The most common examples of operating expenses are listed below:

Examples of Operating Expenses
  • Research & Development (R&D)
  • Sales and Marketing (S&M)
  • Advertising Spend
  • Payroll and Employee Wages
  • Rent and Utilities
  • Travel and Vehicle Expenses
  • Insurance
  • Office Supplies

Operating Income (EBIT) and Operating Margin

On the income statement, the section for operating expenses can be found below gross profit and above operating income (EBIT).

Occasionally, operating expenses can be represented by a single line item, but the standard layout is for the expenses to be broken out into multiple line items.

For example, Apple places “Research & Development” and “Selling, General & Administrative” expenses into separate buckets.

APPL OpEx

Apple Operating Expenses (Source: 2020 10-K)

Operating expenses are paid for using gross profits, which are the earnings once COGS have been subtracted.

By deducting operating expenses from gross profit, the operating profit and operating margin can then be calculated, as shown below.

Operating Profit = Gross Profit – Operating Expenses
  • Operating Margin = EBIT / Revenue

Since operating income takes into account operating costs (i.e. COGS and OpEx), it represents the cash flow from core operations before accounting for other non-core sources of income/expenses.

That said, management should strive to be more efficient and maintain reasonable levels of operating costs, especially because OpEx is a significant component of the break-even point of a company.

Operating Expenses Excel Template

Now that we’ve defined the operating expenses (OpEx) line item, we can complete a modeling exercise in Excel. Fill out the form below to access the file:

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Operating Expenses Example Calculation

In our illustrative example, our company has the following financial data as of Year 0.

Model Assumptions

Income Statement Data (Year 0):

  • Revenue = $125 million
  • Cost of Goods Sold (COGS) = $125 million
  • Selling, General & Administrative (SG&A) = $20 million
  • Research & Development (R&D) = $10 million

Given the assumptions above, the Year 0 gross profit is equal to $65 million and the operating income is $35 million.

  • Gross Profit = $125m – $60m = $65m
  • Operating Income (EBIT) = $65m – $20m – $10m = $35m

The $30 million in SG&A and R&D are the total operating expenses of our company.

Therefore, the gross margin is 52.0% while the operating margin is 28.0% in Year 0.

Operating Expenses Example Projection

Next, we’ll project the income statement of our company down to the operating line.

Revenue will be assumed to grow at a year-over-year growth rate of 5.0% while the gross margin remains at 52.0%.

As for our two operating expenses, SG&A and R&D, the two will remain the same percentage of revenue as Year 0.

Since SG&A as a percentage of revenue was 16.0% and R&D was 8.0% of revenue in Year 0, we’ll extend this across our assumptions section.

SG&A Projection

For each of our operating expenses, we can project the value by multiplying the % assumption by the revenue amount in the matching period, as shown in the screenshot above.

SG&A and R&D Projection Formula
  • SG&A Expense = (SG&A % Revenue) * Revenue
  • R&D Expense = (R&D % Revenue) * Revenue

In the final step, the operating income (EBIT) can be arrived at by deducting the projected SG&A and R&D from gross profit.

Operating Expenses Model

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