Operating Expenses

Operating expenses are the regular costs a business pays to run its day-to-day operations. These costs may include rent, payroll, utilities, insurance, marketing, software, office supplies, and professional fees.

Operating expenses usually do not include the cost of goods sold, capital expenses, interest, or income taxes. Businesses track operating expenses to measure profitability, manage budgets, and understand the cost of running the company. They appear on the income statement and are subtracted from gross profit to calculate operating income.

How operating expenses work

Businesses deduct operating expenses in full during the accounting period in which they occur, unlike capital expenditures, which are depreciated over time. 

Businesses can generally deduct ordinary and necessary trade or business expenses they pay or incur during the tax year, subject to IRS rules and limits. The IRS defines an ordinary expense as one that is common and accepted in the business’s industry and a necessary expense as one that is helpful and appropriate for the business.

Misclassifying a capital expenditure as an operating expense, or treating an operating expense as a capital cost, can distort financial statements and create tax or recordkeeping issues.

Common examples

Operating expenses vary by business, but common examples include:

• Occupancy costs: Rent or lease payments for office, retail, or storage space
• Employee expenses: Wages, payroll taxes, and employee benefits
• Utilities: Electricity, internet, phone service, and other essential business utilities
• Marketing and advertising: Costs for promoting products or services
• Insurance: Premiums for liability, property, or professional insurance coverage
• Office operations: Software subscriptions, office supplies, and other day-to-day administrative expenses
• Professional services: Fees paid to accountants, attorneys, consultants, or other advisors
• Licenses and permits: Business license, permit, and regulatory filing fees

Key characteristics

Operating expenses help show what it costs to keep a business running apart from direct production costs.

• Normal business use: Operating expenses usually support ordinary business operations. Many are recurring, but some may be one-time costs tied to normal operations.
• Current-period treatment: Many operating expenses are recorded or deducted in the current period, but tax rules, accounting methods, limits, and prepayment rules can affect timing.
• Scope. Operating expenses cover administrative, selling, and general costs. They generally exclude cost of goods sold, capital expenditures, interest, income taxes, and owner withdrawals.

Operating expenses vs. capital expenditures

The key distinction is how the cost benefits the business and how it is recorded. Operating expenses are costs that support current operations, such as monthly rent, office supplies, or administrative payroll. Capital expenditures are investments in long-term assets, such as equipment, vehicles, major improvements, or property. These costs are often capitalized and recovered over time through depreciation or amortization, though tax rules may allow accelerated deductions for some qualifying purchases.

Best practices

Businesses can manage operating expenses more effectively by tracking, reviewing, and approving them consistently.

• Keep organized records: Maintain receipts, invoices, account statements, payroll records, and payment confirmations to support expenses and tax deductions.
• Separate personal and business finances: Commingling funds makes it harder to identify legitimate operating expenses and can weaken the separation between the business and its owners.
• Review expenses periodically: Unused subscriptions, redundant services, and rising vendor costs can reduce profitability if they are not reviewed.
• Set approval rules: For LLCs or businesses with multiple owners, an operating agreement or internal policy can explain who may approve expenses and how costs are allocated.

Related terms

These related terms can help explain how operating expenses connect to income statements, taxes, and business cost tracking:

• Cost of goods sold (COGS). COGS includes the direct costs of products a business sells during a specific period.
• Capital expenditure. A capital expenditure is money spent to buy, improve, or extend the life of a long-term business asset.
• Operating income. Operating income is gross profit minus operating expenses.
• Fixed cost: A fixed cost is an expense that stays the same during a specific period, even if sales or production levels change.
• Variable cost. A variable cost is an expense that changes based on production or sales volume.

FAQs about operating expenses

What is excluded from operating expenses?

Operating expenses exclude cost of goods sold, capital expenditures, interest payments on debt, and income taxes. These are classified separately on the income statement.

How do you calculate operating expenses?

To calculate operating expenses, add together all the costs associated with the core operations of the company, such as salaries, rent, and utilities.

What are fixed vs. variable operating expenses?

Fixed costs remain constant regardless of business activity, such as rent and insurance. Variable costs fluctuate with activity levels, such as sales commissions and shipping. Businesses can deduct both in full during the period they incur them.

Does depreciation count as an operating expense?

Businesses typically record depreciation on assets used in daily operations, such as office equipment and company vehicles, as an operating expense, though it does not represent a current cash outlay. This distinguishes it from the capital expenditure that originally gave rise to it.

Are operating expenses the same as cost of goods sold?

No, operating expenses and COGS are distinct categories on the income statement. COGS includes costs directly tied to the production of goods sold by the company, while OPEX encompasses costs related to general business operations.