What are Operating Expenses?
Operating Expenses (OpEx) represent the indirect costs incurred by a business to continue running its day-to-day operations. While not directly tied to the revenue generated from the products/services, operating expenses are an essential part of a company’s core operations.
How to Calculate Operating Expenses?
Operating expenses (OpEx) are associated with the core operations of a company, but do not directly contribute to the production of the products or services 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 OpEx 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.
What are Examples of Operating Expense?
The most common examples of operating expenses incurred by companies are listed below:
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Operating Expenses on Income Statement Example
On the income statement, the section for operating expenses can be found below gross profit and above operating income (EBIT).
Occasionally, OpEx can be consolidated into 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.
Apple Operating Expenses (Source: 2020 10-K)
Operating expenses are paid for using gross profits, which are the earnings once COGS have been subtracted.
How OpEx Impacts Operating Income (EBIT) and Operating Margin?
By deducting operating expenses from gross profit, the operating profit (EBIT) and operating margin can then be calculated, as shown below.
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 Calculator
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Step 1. Income Statement Assumptions
In our illustrative example, our company has the following financial data as of Year 0.
Income Statement Data (Year 0)
- Revenue = $125 million
- Cost of Goods Sold (COGS) = $60 million
- Selling, General & Administrative (SG&A) = $20 million
- Research & Development (R&D) = $10 million
Step 2. Operating Expenses Calculation and EBIT Analysis
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.
Step 3. Operating Expenses Projection (R&D and SG&A)
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.
For each period, we can project the OpEx value by multiplying the % assumption by the revenue amount in the matching period, as shown in the screenshot above.
In the final step, the operating income (EBIT) can be arrived at by deducting the projected SG&A and R&D from gross profit.
