You’re staring at your income statement, and somehow 65% of your revenue has vanished into “operating expenses”, but you’re not entirely sure what that even means or if you’re spending too much.
You’re about to discover exactly what counts as operating expenses, how to calculate them accurately, and proven tactics to cut costs without sacrificing quality.
With rising costs and tighter margins, understanding your operating expenses isn’t just good practice – it’s survival.
This guide walks you through the essentials with practical examples, industry benchmarks, and a clear action plan.
Let’s get started.
Key Takeaways
- Operating expenses (OpEx) are the recurring, indirect “keep the business running” costs, not the direct costs of producing or delivering what you sell.
- Getting OpEx, CapEx, and COGS right is essential because misclassifications distort profitability and can create tax/reporting issues.
- Breaking OpEx into fixed, variable, and mixed costs (plus SG&A) shows what’s locked-in vs. controllable when revenue shifts.
- You can calculate OpEx two ways: add up the qualifying categories, then verify the result using the income statement to confirm accuracy.
- The Operating Expense Ratio (OpEx ÷ Revenue) helps you track efficiency and spot early warning signs when costs rise faster than sales.
- Benchmarks only matter in context; industry, business stage, and location can significantly shift “normal” OpEx ranges.
- The best cost cuts are targeted: subscription cleanup, vendor renegotiation, automation, space optimization, insurance reviews, energy efficiency, and clear spending policies.
- Solid recordkeeping simplifies OpEx management, clarifies business vs. personal spending, and provides necessary documentation.
What Are Operating Expenses?
You’ve probably heard the term thrown around in accounting meetings or seen it on your income statement, but here’s what it really means: Operating expenses (OpEx) are the ongoing costs you pay to keep your business running day-to-day.
These are the “keeping the lights on” expenses – rent, utilities, salaries, insurance, marketing, and office supplies.
They’re everything you need to operate, excluding the direct costs of making your products or delivering your services.
Here’s the key distinction: Operating expenses are indirect costs. Whether you sell one product or one thousand this month, you’re still paying rent, keeping the electricity on, and compensating your administrative team. That’s what makes them different from direct production costs.
What makes something an operating expense? It needs to meet these criteria:
- Recurring: You pay it regularly (monthly, quarterly, or annually)
- Indirect: It’s not directly tied to producing your product
- Necessary: Your business needs it to function
- Tax-deductible: Most OpEx qualify as deductions under IRS “ordinary and necessary” rules
Operating expenses typically include:
- Administrative and office staff salaries
- Rent and lease payments for facilities
- Utilities like electricity, water, internet, and phone
- Insurance premiums (liability, property, workers’ comp)
- Marketing and advertising costs
- Office supplies and equipment
- Professional fees for legal and accounting services
- Maintenance and repairs
- Depreciation and amortization
- Travel and vehicle expenses
What’s NOT an operating expense? This trips people up constantly. Cost of goods sold (COGS)—like raw materials and production labor—aren’t operating expenses. Neither are interest payments on loans, or capital expenditures like buying equipment. We’ll dig into these distinctions in the next section.
Operating Expenses vs Capital Expenditures vs COGS
Ever wonder why your accountant keeps asking whether that $5,000 equipment purchase is a repair or an upgrade? Here’s why it matters:
Misclassifying expenses doesn’t just mess up your financial reports; it can cost you thousands in incorrect tax deductions and give you a completely distorted view of profitability.
Let’s break down the three main expense categories you’ll encounter:
- Operating Expenses (OpEx): These are your day-to-day running costs. Think rent, utilities, administrative salaries, insurance, and marketing. You expense them immediately in the year you incur them, and they show up on your income statement. The IRS lets you deduct them fully in the year they happen.
- Capital Expenditures (CapEx): These are long-term investments in assets that last more than one year. When you buy a delivery van, purchase manufacturing equipment, or acquire a building, that’s CapEx. Instead of expensing it all at once, you capitalize it on your balance sheet and depreciate it over several years. The tax benefit spreads out over time.
- Cost of Goods Sold (COGS): These are the direct costs tied to producing your product or service. Raw materials, production labor, manufacturing overhead—if it varies directly with how much you produce, it’s COGS. This sits between revenue and gross profit on your income statement.
Types of Operating Expenses: Fixed, Variable, and SG&A Breakdown
With the big distinctions out of the way, let’s look at how operating expenses break down into different categories.
Not all operating expenses behave the same way, and understanding these differences helps you manage cash flow and make smarter decisions during both boom times and slow periods.
Fixed Operating Expenses stay constant regardless of how much business you’re doing. Whether you have your best month ever or your worst, these costs remain the same.
Fixed expense examples:
- Monthly rent or lease payments
- Insurance premiums (paid annually or monthly)
- Salaried employee wages (for admin and office staff)
- Annual software licenses
- Property taxes
- Depreciation on equipment and vehicles
Why this matters: Fixed expenses give you predictability when budgeting, but they become dangerous during downturns because they don’t automatically decrease when revenue drops. If you’re locked into a $5,000/month lease and sales plummet, you’re still paying $5,000.
Variable Operating Expenses fluctuate based on your business activity and sales volume. These costs rise when you’re busy and fall when things slow down.
Variable expense examples:
- Sales commissions (tied to revenue)
- Credit card processing fees (percentage of sales)
- Shipping and freight costs (per order)
- Marketing campaigns (you control spending)
- Hourly wages for part-time staff
- Travel and entertainment expenses
Why this matters: Variable expenses provide flexibility—they naturally scale with your business. During slow periods, they automatically decrease, giving you breathing room. But you need to watch them carefully because unchecked variable costs can quickly eat into margins during growth periods.
Semi-Variable (Mixed) Operating Expenses have both fixed and variable components—a base cost you always pay, plus additional charges based on usage.
Semi-variable expense examples:
- Utilities: Base connection fee + usage charges
- Phone and internet: Base plan + overage charges
- Vehicle expenses: Insurance and registration (fixed) + fuel and maintenance (variable)
Selling, General & Administrative (SG&A) Expenses is how most income statements group operating expenses. You’ll see this term on financial reports, and it’s just an umbrella category covering three areas:
- Selling expenses: Sales team salaries, commissions, advertising, trade show costs, promotional materials
- General expenses: Rent, utilities, office supplies, insurance
- Administrative expenses: Executive salaries, accounting and legal fees, HR costs, office management
According to BDC research, SG&A typically represents 15-25% of revenue for most businesses, though this varies significantly by industry. Service businesses run higher (30-40%), while manufacturing businesses often run lower (15-20%).
Why categorizing matters: When you know which expenses are fixed vs. variable, you can make better decisions. During a cash crunch, you can’t easily cut rent (fixed), but you can pause marketing campaigns (variable) or reduce discretionary travel (variable). When planning growth, you understand which costs will scale automatically and which require new commitments.
How to Calculate Operating Expenses?
You’re probably thinking, “Can’t I just add up my bills?” Well, yes, but there’s a right way to do it that gives you actionable insights, and a wrong way that leaves you guessing whether you’re spending too much.
Method 1: Direct Addition Method (Most Common)
This is the straightforward approach—you add up all your operating expense categories.
Formula:
Operating Expenses = Rent + Utilities + Salaries + Insurance + Marketing + Office Supplies + Professional Fees + Depreciation + Other OpEx
Step-by-step:
- Gather expense records for your chosen period (month, quarter, or year)
- Separate operating expenses from COGS and capital expenditures
- Add up every qualifying operating expense category
- Double-check you haven’t included production costs or asset purchases
Real example—Small Marketing Agency:
- Rent: $2,500/month
- Utilities: $400/month
- Administrative salaries: $12,000/month
- Insurance: $600/month
- Marketing and advertising: $1,500/month
- Office supplies: $250/month
- Professional fees (accounting, legal): $800/month
- Software subscriptions: $500/month
- Depreciation: $300/month
- Total Monthly Operating Expenses: $18,850
Method 2: Income Statement Method (Verification Approach)
Use this when you want to verify your calculation or when working backward from financial statements.
Formula:
Operating Expenses = Revenue – Operating Income – COGS
Step-by-step:
- Find your total revenue for the period
- Subtract your COGS to calculate gross profit
- Identify your operating income (also called EBIT)
- Subtract operating income from gross profit—what remains is your operating expenses
Real example—E-commerce Business:
- Revenue: $100,000
- COGS: $40,000
- Gross Profit: $60,000
- Operating Income (EBIT): $22,000
- Operating Expenses = $60,000 – $22,000 = $38,000
Now calculate your Operating Expense Ratio (OER)—this is where it gets useful.
The OER tells you what percentage of every revenue dollar goes to operating expenses. This is your key metric for benchmarking against industry standards and tracking trends over time.
Formula:
Operating Expense Ratio = (Operating Expenses ÷ Total Revenue) × 100
Using our e-commerce example:
- Operating Expenses: $38,000
- Revenue: $100,000
- OER = ($38,000 ÷ $100,000) × 100 = 38%
What does this mean? For every dollar this business earns, 38 cents goes to operating expenses. Whether that’s good or bad depends on your industry (we’ll cover benchmarks in the next section).
Red flags to watch for:
- OER increasing month-over-month without revenue growth
- OER exceeding 80% of gross profit
- Operating expenses growing faster than revenue
Industry Benchmarks: What's Normal for Your Business?
Now that you can calculate your operating expenses, let’s answer the question keeping you up at night: “Am I spending too much?”
Raw numbers don’t tell you much without context. Your $38,000 monthly OpEx might be fantastic or terrible depending on your industry, business model, and stage of growth.
Here's what's typical across major industries:
| Industry | OpEx as % of Revenue | Key Cost Drivers |
|---|---|---|
| Restaurants & Food Service | 30–35% | Labor, rent, utilities |
| Retail (Physical Stores) | 20–30% | Rent, staffing, utilities |
| E-commerce | 15–25% | Marketing, fulfillment, platform fees |
| SaaS & Software | 30–45% | Salaries, hosting, customer support |
| Manufacturing | 15–25% | Overhead, admin, maintenance |
| Professional Services | 40–60% | Salaries, office rent, tools |
| Healthcare Practices | 35–50% | Staff, facilities, compliance |
| Construction | 20–30% | Equipment, insurance, admin |
Why do service businesses run higher? Because their primary “product” is people. A consulting firm or law practice might spend 50-60% of revenue on operating expenses, and that’s perfectly normal—most of those dollars go to talented professionals who generate the revenue.
Why do product businesses run lower? Because their major costs sit in COGS (raw materials, production labor), not operating expenses. A manufacturer might spend only 20% on OpEx but 60% on COGS.
Important context that changes everything:
Business stage matters tremendously:
- Startups (Year 1-2): Expect 50-80% OpEx ratios as you invest in growth, infrastructure, and customer acquisition
- Growth stage (Year 3-5): Plan for 35-60% as you scale, but haven’t yet achieved full efficiency
- Mature businesses (Year 6+): Target 15-40% with optimized operations and established systems
Geographic location impacts costs:
- Urban areas (New York, San Francisco, Seattle): Add 20-40% to rent and labor costs
- Suburban locations: Moderate costs with good talent access
- Rural areas: Lower rent but potentially higher shipping/logistics costs
Business model variations:
- Brick-and-mortar: Higher rent and utilities
- Remote-first: Lower facilities costs but higher software/communication costs
- Hybrid: Somewhere in between
What this means for you: Don’t compare your OpEx to a business in a completely different industry. A consulting firm spending 50% on operating expenses isn’t wasteful—it’s normal. But an e-commerce business at 50% needs to investigate. Know your industry baseline, then work to beat it.
7 Proven Strategies to Reduce Operating Expenses
Now let’s tackle the question that matters most: How do you actually reduce these costs without hurting your business?
You don’t need to slash quality, fire good people, or move into a storage unit to cut operating expenses. Smart cost management focuses on efficiency and eliminating waste—not scorched-earth budget cuts.
Strategy #1: Audit and Eliminate Subscription Waste
Most businesses are paying for software they don’t use. According to a Productiv study, companies waste an average of 30% of their SaaS spending on unused or redundant tools.
Action steps:
- Pull your credit card and bank statements for the last 3 months
- List every recurring subscription (software, memberships, services)
- Check usage—when did you last log in? Who actually uses it?
- Cancel anything unused for 60+ days
- Consolidate overlapping tools (Do you need both Slack and Microsoft Teams?)
Potential savings: 15-25% of software costs, often $200-500/month for small businesses
Strategy #2: Negotiate with Vendors Annually
Loyalty doesn’t pay—literally. Vendors expect you to ask for better rates, and they have the room to discount if you know how to ask.
Action steps:
- Request quotes from 2-3 competing vendors before renewal
- Call your current providers and mention you’re reviewing alternatives
- Ask directly: “What’s your best rate for a loyal customer?”
- Lock in longer terms (annual vs. monthly) for 10-20% discounts
- Bundle services where possible (internet + phone, multiple insurance policies)
Potential savings: 10-20% on recurring vendor expenses like insurance, internet, office supplies
Strategy #3: Automate Repetitive Administrative Tasks
Manual data entry, invoice processing, and expense tracking are costing you hours every week—hours you’re paying for.
Action steps:
- Implement accounting automation for bank reconciliation and categorization
- Use automated invoicing with payment reminders
- Set up automated expense tracking with receipt capture (mobile photo → software)
- Automate payroll processing and tax filing
- Use workflow tools to reduce email back-and-forth
Potential savings: 20-30% of administrative labor costs. For a business spending $3,000/month on bookkeeping, that’s $600-900/month saved.
Strategy #4: Optimize Your Office Space
Commercial real estate is often your second-largest operating expense after payroll. The pandemic proved most knowledge work doesn’t require expensive downtown office space.
Action steps:
- Consider hybrid or remote models (2-3 days in-office vs. 5)
- Downsize to smaller space or move to more affordable areas
- Explore co-working spaces with flexible month-to-month terms
- Negotiate lease renewals 6-9 months before expiration
- Sublet unused space if your lease allows
Potential savings: 20-40% on rent and facilities, potentially $1,000-3,000/month
Strategy #5: Review Insurance Coverage Annually
Insurance is essential, but you’re probably over-insured in some areas and under-insured in others. Rates change, and so do your needs.
Action steps:
- Get quotes from 3 different providers every year
- Adjust coverage levels based on current asset values
- Increase deductibles if you have adequate cash reserves (higher deductible = lower premium)
- Bundle policies (liability + property + workers’ comp) for multi-policy discounts
- Ask about claims-free discounts or safety program credits
Potential savings: 10-25% on insurance premiums, often $100-400/month
Strategy #6: Implement Energy Efficiency Measures
Utility costs quietly drain thousands annually. Small changes compound into significant savings.
Action steps:
- Switch to LED lighting throughout your facility (pays for itself in 6-12 months)
- Install programmable thermostats to avoid heating/cooling empty buildings
- Upgrade to Energy Star-rated equipment when replacing old items
- Conduct a free energy audit (many utilities offer these)
- Fix leaks, improve insulation, and seal drafts
Potential savings: 15-30% on utility costs, typically $50-200/month for small businesses
Strategy #7: Control Discretionary Spending with Policies
The little purchases add up fast—$40 here for lunch, $150 there for office supplies, $300 for an unplanned subscription.
Action steps:
- Set approval thresholds ($100+, $500+, $1,000+)
- Require expense pre-approval for travel, entertainment, and non-routine purchases
- Use expense management software for real-time visibility
- Review spending reports monthly to catch anomalies
- Create clear policies for meals, travel, and office supplies
Potential savings: 10-20% on discretionary costs, typically $200-500/month
Quick win to start today: Strategy #1 (subscription audit) takes 30 minutes and can save you $200-500/month with zero business impact. Start there.
Common Operating Expense Mistakes to Avoid
Even experienced business owners mess these up, and the consequences range from confusing financial reports to paying thousands more in taxes than necessary.
Mistake #1: Mixing COGS and Operating Expenses
The problem: Including production costs like raw materials or factory labor in your operating expenses inflates your OpEx ratio and hides your true gross profit margin. This makes it impossible to understand whether you have a pricing problem or an overhead problem.
The fix: Ask yourself: “Does this cost vary directly with how much I produce or sell?” If yes, it’s COGS. If no, it’s an operating expense. Direct production labor = COGS. Administrative staff = OpEx. Materials for products = COGS. Office supplies = OpEx.
Mistake #2: Expensing Major Repairs That Should Be Capitalized
The problem: That $12,000 HVAC system replacement extends your building’s useful life significantly—it should be capitalized and depreciated, not expensed immediately. Treating it as an operating expense understates your assets and overstates current-year expenses, distorting profitability.
The fix: Use this simple rule: Repairs that restore equipment to working condition = OpEx. Improvements that add value, extend useful life, or upgrade capability = CapEx. Fixing a leak = OpEx. Replacing an entire roof = CapEx.
Mistake #3: Only Reviewing Operating Expenses at Year-End
The problem: By December, you’ve already spent the money. That $200/month subscription you forgot about has cost you $2,400, and that gradual 15% increase in utility costs has eaten an extra $3,000.
The fix: Review operating expenses monthly. Create a simple dashboard tracking your top 10 expense categories month-over-month. Set alerts when any category exceeds budget by 10% or more. Catch problems in February, not December.
Mistake #4: Not Separating Fixed from Variable Costs
The problem: When revenue drops and you need to cut costs quickly, you’re scrambling to figure out what’s controllable. You might slash marketing (variable, controllable) while ignoring wasteful subscriptions (fixed, controllable) or try to renegotiate rent (fixed, difficult) while ignoring commission structures (variable, easily adjusted).
The fix: Tag every operating expense as fixed, variable, or semi-variable in your accounting software. During planning sessions, you’ll immediately see where you have flexibility and where you’re locked in.
Mistake #5: Ignoring Small Recurring Charges
The problem: A $49/month software subscription doesn’t feel significant, but 20 of them cost $11,760 annually. These “micro-expenses” slip through because no single charge triggers attention, but collectively they’re bleeding cash.
The fix: Run a quarterly “subscription audit.” Export all transactions, filter for recurring charges, and challenge every single one. Can’t remember what “ACM Services $29.99” is? Cancel it and see who complains (probably no one).
Mistake #6: Using Personal Accounts for Business Expenses
The problem: When business and personal finances mix, you lose track of actual operating expenses, miss tax deductions, and create a nightmare for accountants and auditors. You’re probably missing thousands in deductions because you forgot to track legitimate business expenses paid from personal accounts.
The fix: Separate accounts completely. Get a business credit card and use it exclusively for business. Use expense tracking software that captures receipts automatically. If you do pay a business expense personally, log it immediately and reimburse yourself properly.
Mistake #7: Forgetting to Track Receipt Documentation
The problem: Come tax time, you’re claiming $45,000 in operating expense deductions, but you can only prove $32,000 with actual receipts. The IRS audits your return, disallows $13,000 in deductions, and you owe back taxes plus penalties. This happens more than you think.
The fix: Use mobile receipt capture tools (many accounting software platforms include this). Take a photo of every receipt over $75 immediately. For meals and travel, note the business purpose on the receipt. Store digitally—paper fades and gets lost.
Operating Expenses and Tax Deductions: What You Need to Know
Now let’s talk about everyone’s favorite topic—taxes (or more specifically, how to pay less of them legally).
Most operating expenses are tax-deductible, but knowing the rules helps you maximize deductions while staying compliant. Miss deductions, and you’re giving the IRS a free loan. Claim the wrong things, and you’re inviting an audit.
The IRS’s Golden Rule for Deductible Operating Expenses:
To qualify as deductible, operating expenses must meet two criteria according to IRS Publication 535:
- Ordinary: Common and accepted in your industry or trade
- Necessary: Helpful and appropriate for your business (not required to be indispensable, just reasonable)
This is actually pretty generous—”helpful” is a low bar. Your business doesn’t need that conference ticket to survive, but if it helps you learn and network, it’s deductible.
Fully Deductible Operating Expenses (100%):
These you can deduct in full during the year you pay them:
- Rent and lease payments for business property
- Utilities used for business purposes (electricity, water, internet, phone)
- Salaries and wages for employees (not owner compensation for certain business types)
- Insurance premiums (liability, property, workers’ comp, malpractice)
- Professional fees (accountants, lawyers, consultants)
- Office supplies and equipment under $2,500
- Advertising and marketing costs
- Depreciation using IRS depreciation schedules
- Bank fees and merchant processing fees
- Business licenses and permits
Partially Deductible Operating Expenses (50%):
Here’s where it gets tricky—some expenses have limitations:
- Business meals: 50% deductible (meal with a client or employee for business purposes)
- Entertainment: Generally not deductible as of 2018 (goodbye, sports tickets for clients)
Special Cases Requiring Calculation:
- Home Office: Deductible based on the percentage of your home used exclusively for business (simplified method: $5 per square foot up to 300 sq ft, or actual expense method)
- Vehicle Expenses: Deductible based on business use percentage (either standard mileage rate—67 cents per mile in 2024—or actual expenses like gas, insurance, repairs)
- Travel: Transportation and lodging are 100% deductible, meals during travel are 50% deductible
What’s NOT Deductible:
Don’t even try claiming these:
- Personal expenses (even if paid from a business account)
- Capital expenditures (these get depreciated instead of expensed)
- Political contributions or lobbying expenses
- Fines, penalties, and traffic tickets
- Commuting costs from home to your regular workplace (business travel between job sites is deductible)
Record-Keeping Requirements (This Matters for Audits):
The IRS isn’t taking your word for it. You need documentation:
- Keep all receipts for expenses over $75
- Document business purpose for meals and travel (who, where, why)
- Maintain detailed mileage logs for vehicle deductions (date, destination, miles, business purpose)
- Save invoices and contracts for services
- Track home office square footage and calculations
- Store records for at least 3 years (7 years is safer)
Tax tip you can’t ignore: Operating expenses are deducted in the year incurred, giving you immediate tax relief. Capital expenditures must be depreciated over multiple years (3-39 years, depending on the asset), delaying the full tax benefit. This is why correctly classifying expenses matters so much.
According to the IRS, you can deduct ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, but you must have adequate records to prove both the amount and business purpose.
The Bottom Line
Mastering operating expenses isn’t just about cutting costs. It’s about understanding where your money goes, why it matters, and how to build a system that supports profitable, predictable growth.
The problem is that most businesses don’t have the financial clarity or processes needed to manage OpEx strategically. That’s where Ledger Labs helps.
For more than a decade, we’ve helped small businesses clean up expenses, streamline accounting systems, and build real financial visibility.
If you want expert guidance, sharper cost control, and better profitability, book a call with Ledger Labs and take the guesswork out of managing your operating expenses.
