The income statement is a financial statement that reports a company’s performance for a period. It is one of the most favorite reports for investors. Usually, it presents the profits or losses a company makes during a period. The income statement also reports on activity through income and expenses. These items are crucial in helping companies calculate their earnings for a period.
One of the primary objectives of the income statement is to present profits or losses. It is why companies also call it the statement of profit or loss. On top of that, it also classifies those items into several categories. For example, companies report their gross, operating, and net profits or losses. The calculation for these items differs based on the division of various expenses.
Dividing expenses under several headings is crucial in helping calculate different types of profits. Usually, companies report those expenses under three or four categories. One includes operating expenses, which help calculate operating profits or losses. Companies may also present other operating expenses in the income statement. Before discussing that, it is crucial to understand what operating expenses include.
What are Operating Expenses?
Operating expenses represent costs incurred by companies to perform their operations. These costs come from supporting activities vital to maintaining the core activities. Essentially, operating expenses occur in specific areas. If a cost occurs outside those areas, companies must classify it under a different heading. Operating expenses are one of the most substantial items on the income statement.
Operating expenses come from usual business operations. These may include several costs, such as rent, salaries, wages, equipment, insurance, etc. However, they constitute both indirect costs for a company. It implies they do not relate to the core activities that companies perform. Essentially, these expenses are indirect to providing products or services. Nonetheless, they are vital to support the process.
Operating expenses are also known as OPEX or operating costs. These are prevalent for companies in all stages. For example, even startups in their initial phases must incur these costs. Operating expenses usually do not depend on the activity levels of a company’s core processes. Essentially, these expenses include fixed costs that do not fluctuate with production levels. However, they are not entirely independent of those levels either.
Overall, operating expenses are costs incurred on operations. These costs come from secondary activities that companies perform to support core operations. Separating these expenses is crucial in calculating operating profits or losses. In the income statement, these expenses appear after the gross profit calculation. This heading includes various types of costs.
What Are the Types of Operating Expenses?
Operating expenses do not represent a specific cost during operations. Instead, it accumulates various items related to business activities within a company. These items may cover several costs. Usually, companies provide a breakdown of operating expenses in the notes to the financial statements. The most prevalent types of operating expenses include several fixed costs.
Operating expenses do not depend on activity levels. Therefore, they usually include fixed costs or semi-fixed costs. Essentially, these costs occur regardless of the activity levels during a period. Companies may further divide these expenses into several headings. For example, they may include administrative, selling, marketing, or other expenses. Nonetheless, they fall under operating expenses on the income statement.
One of the most prevalent items in operating expenses is salaries and payroll expenses. These involve compensation paid to employees for their work. Usually, they include salaries, wages, commissions, benefits, bonuses, pension plan contributions, etc. On top of that, operating expenses also include payments to other similar parties. For example, it may consist of outsourcing expenses, etc.
Some other prevalent items appearing under operating expenses in the income statement are as follows.
- Rent for office buildings or premises.
- Sales materials.
- Travelling and freight expenses.
- Direct mailings and postal costs.
- Entertainment provided to suppliers, customers and clients.
- Depreciation expense for assets used in operations.
- Bad debts from irrecoverable debts.
- Allowance for doubtful debts.
- Repair and maintenance for office equipment or similar resources.
Most of these costs do not depend on activity levels. However, they may increase in stepped amounts rather than variable costs. Budgeting for operating expenses is also more straightforward due to their predictability. However, some of these costs may also occur unexpectedly. In either case, they will relate to a company’s operations.
What is the Difference Between Operating and Non-Operating Expenses?
The difference between operating and non-operating expenses is apparent from their names. Operating expenses are any costs incurred toward business activities. Usually, they come from within the business. However, non-operating expenses come from other sources. Some people may think of these expenses as costs that don’t fall under the operating category. However, that is not the case.
Operating expenses include any items that relate to a company’s operations. However, non-operating expenses don’t relate to the core business activities. Instead, they come from other sources, such as financing and legal issues. These expenses are also critical as they reduce profits. However, investors may ignore them during their decision-making. Non-operating expenses appear after operating expenses in the income statement.
Essentially, operating expenses are costs that companies must incur to perform their operating activities. On top of that, these expenses help generate revenues. Hence, they contribute to the operations performed by companies to continue the business. Non-operating expenses, in contrast, don’t play a role in creating revenues. Even in their absence, companies can continue their operations.
Non-operating activities may also include items related to accounting treatments. For example, a company may report losses from investments under this head. Similarly, losses on foreign currency transactions also fall under this head. Companies also include impacts of changes in accounting principles under these expenses. Apart from these, non-operating expenses include financial costs, inventory write-downs, provisions, etc.
What are Other Operating Expenses?
As stated above, various prominent items appear under operating expenses. The most prevalent of these include salaries and wages. Beyond that, companies also report other costs, such as rent, utilities, and similar items under operating expenses. However, companies may also present other operating expenses under this head. In most cases, these expenses differ from the prevalent items listed above.
Other operating expenses represent various negligible costs in the income statement. Usually, companies determine the material items they must report as separate line items. As mentioned above, these may include salaries, rent, utilities, etc. However, other amounts may remain. Companies can report these items individually on the income statement.
However, if the amounts are insignificant, companies may combine those items. If they choose to do so, they will term them as other operating expenses. Usually, they include the following items.
- Outsourcing costs.
- Rental expense on property, plant and equipment.
- Cost of spare parts and other small items.
- Repair and maintenance expenses.
- Insurance premiums.
- Research and study costs.
- Professional expenses.
- Insignificant travel expenses.
- Postal charges.
- Transportation charges.
Other operating expenses are also known as overhead expenses. Similarly, these expenses do not depend on sales or production levels. Other operating expenses will differ from one company to another. Usually, companies must determine which items they put under this head. In most cases, these will include immaterial or insignificant accounts.
Conclusion
Operating expenses are costs incurred toward a company’s operations. These costs are crucial in supporting core activities. On top of that, they also contribute to the revenues generated by companies. These expenses differ from non-operating activities. Companies can also accumulate various insignificant items in this head. Usually, they report that sum as other operating expenses.