What are Operating Expenses in Accounting?
Operating expenses are all costs incurred in the day-to-day running of a business. This includes both fixed and variable costs that are necessary to maintain business activity and generate revenue. Understanding operating expenses is essential for budgeting , cost analysis , and effective accounting .
What are Operating Costs?
Operating expenses represent all ongoing expenses that a business incurs to conduct its ordinary business activities. These costs are directly related to day-to-day operations and are distinct from investment and financial costs.
Characteristics of Operating Costs
- Ongoing nature: Occurs regularly during the operating period
- Necessary for operations: Essential to maintain business activity
- Impact on earnings: Reduces gross profit and operating profit
- Tax deduction: Can be deducted from the tax base
- Accrual: Must be recorded in the period in which they are incurred.
Types of Operating Costs
Operating costs can be classified in several ways depending on their nature and behavior in relation to the level of activity.
Fixed Operating Costs
Fixed costs remain constant regardless of the level of production or activity within a relevant area.
Examples of Fixed Operating Costs:
- Rent and local costs
- Insurance premiums
- Basic salary for employees
- Depreciation
- Licenses and subscriptions
- Accounting and auditing fees
Variable Operating Costs
Variable costs change proportionally with activity or production volume.
Examples of Variable Operating Costs:
- Raw materials and supplies
- Commission salary
- Shipping and transportation costs
- Energy costs (partial)
- Maintenance costs
- Sales commission
Semi-Variable Operating Costs
Semi-variable costs have both a fixed and a variable component.
Examples of Semi-Variable Costs:
- Phone bills: Fixed subscription + variable usage
- Electricity bills: Fixed network rental + variable consumption
- Leasing agreements: Fixed base rent + variable kilometer-based cost
Classification of Operating Costs
By Function
Operating expenses can be grouped by which function they support in the business:
| Function | Cost types | Examples |
|---|---|---|
| Production | Direct and indirect production costs | Raw materials, production wages, machine operation |
| Sale | Selling expenses | Marketing, sales commission, trade fairs |
| Administration | Administrative costs | Office management, management, IT systems |
| Distribution | Distribution costs | Shipping, warehousing, packaging |
After Controllability
Controllable Costs
Costs that management can influence in the short term: * Marketing costs * Overtime pay * Travel expenses * Consulting fee
Uncontrollable Costs
Costs that are difficult to influence in the short term: * Rent (for long-term contracts) * Insurance premiums * Depreciation * Basic salary
Accounting for Operating Costs
Basic Principles
Operating expenses shall be accounted for according to the accrual principle and the matching principle :
- Accrual accounting: Costs are recorded when they are incurred, not when they are paid.
- Matching: Costs are matched against related revenues
- Caution: Uncertain costs should be taken into account
Typical Operating Expense Accounts
| Account type | Account number | Description |
|---|---|---|
| Salaries and social costs | 5000-5999 | Salary, employer's social security contributions , pension |
| Other operating costs | 6000-6999 | Rent, insurance, maintenance |
| Depreciation | 7000-7999 | Ordinary depreciation |
| Financial costs | 8000-8999 | Interest costs, currency differences |
Example of Accounting
Monthly rent of 50,000 NOK:
Debet: 6100 Husleie lokaler 50.000
Kredit: 2400 Leverandørgjeld 50.000
Salary payment of 200,000 NOK:
Debet: 5000 Lønn 200.000
Kredit: 1900 Bankinnskudd 200.000
Operating cost analysis
Cost structure analysis
Analysis of operating costs provides important insight into a business's cost structure and profitability .
Important Key Figures:
- Operating costs as a % of revenue
- Fixed costs as a % of total operating costs
- Variable costs per unit
- Contribution margin per product/service
Break-Even Analysis
The break-even point shows how much the business must sell to cover all operating costs:
Break-even = Faste kostnader ÷ (Salgspris per enhet - Variable kostnader per enhet)
Example: Break-Even Calculation
A business has: * Fixed operating costs: 500,000 NOK/month * Variable costs: 200 NOK per unit * Selling price: 500 NOK per unit
Calculation: * Contribution margin per unit: 500 - 200 = 300 NOK * Break-even: 500,000 ÷ 300 = 1,667 units per month
Budgeting of Operating Costs
Budget planning
Effective budgeting of operating costs requires:
- Historical analysis: Review of previous years' costs
- Trend Analysis: Identifying Cost Trends
- Activity-based budgeting: Link to expected activity level
- Scenario Planning: Budgets for Different Activity Levels
Budget follow-up
| Month | Budget | Actual | Deviation | Deviation % |
|---|---|---|---|---|
| January | 450,000 | 465,000 | 15,000 | 3.3% |
| February | 450,000 | 442,000 | -8,000 | -1.8% |
| March | 460,000 | 478,000 | 18,000 | 3.9% |
| Q1 Total | 1,360,000 | 1,385,000 | 25,000 | 1.8% |
Optimization of Operating Costs
Cost Reduction Strategies
Short-term Measures:
- Negotiation with suppliers
- Energy saving measures
- Reduction of non-essential costs
- Improved inventory management
Long-term Measures:
- Automation of processes
- Outsourcing of non-core activities
- Investment in energy-efficient solutions
- Workflow reorganization
Cost-Benefit Analysis
When assessing cost measures, one should analyze:
- Savings potential
- Implementation costs
- Risk of quality reduction
- Impact on customer satisfaction
- Long-term consequences
Operating Costs vs. Other Cost Types
Comparison of Cost Types
| Cost type | Character | Accounting | Examples |
|---|---|---|---|
| Operating costs | Ongoing, ordinary | Income statement | Wages, rent, raw materials |
| Investment costs | One-time costs | Balance (activated) | Machinery, buildings |
| Financial costs | Financing-related | Income statement | Interest rates, currency differences |
| Extraordinary costs | Rare, unusual | Income statement | Natural disasters, restructuring |
Tax Aspects
Deduction for Operating Costs
General conditions for deductions: * The cost must be incurred to earn income * The cost must be actually incurred. * The cost must be reasonable and necessary * The cost must be documented.
Non-Deductible Costs
Certain operating costs do not provide tax deductions: * Representation beyond certain limits * Private costs mixed with business costs * Fines and penalties * Gifts above set limits
Reporting and Analysis
Monthly Operating Cost Report
A structured report should contain:
Cost overview:
- Total operating costs
- Breakdown by cost categories
- Comparison with budget
- Comparison with previous period
Key analyses:
- Costs per employee
- Costs as a % of revenue
- Development in cost levels
- Cost driver identification
KPIs for Operating Costs
Important Key Figures:
- Operating expense ratio: Operating expenses ÷ Revenue
- Cost per customer: Total operating costs ÷ Number of customers
- Productivity index: Turnover ÷ Number of employees
- Cost-effectiveness: Operating costs ÷ Units produced
Digitalization and Operating Costs
Modern Cost Management Tools
- ERP systems: Integrated cost management
- Automated journal entry : Reduced administrative costs
- Predictive Analytics: Improved Budget Planning
- Dashboards: Real-time cost overview
Future Trends
- Artificial intelligence in cost optimization
- Automation of routine tasks
- Sustainable operating costs
- Activity-based cost modeling
Conclusion
Operating costs are a fundamental part of any business's finances and require continuous attention and management. Effective management of operating costs through:
- Systematic classification and registration
- Regular analysis and follow-up
- Proactive budgeting and planning
- Continuous optimization of cost levels
This not only ensures good accounting , but also the basis for strategic decisions and long-term profitability . By understanding the relationship between operating costs and contribution margin , businesses can make informed decisions about pricing, product mix and investments.
Modern technology and digital tools make it easier than ever to monitor, analyze, and optimize operating costs, providing competitive advantage to businesses that effectively leverage these opportunities.