Operating Costs vs Expenses: What are the Key Differences

As a business owner, it’s crucial to understand operating costs vs operating expenses.

Having a clear picture of the money coming in and out of your company improves your ability to do everything from planning payroll to renting office space to hiring new employees.

Today, we’re taking the process step by step, from how to break down your income statement to calculating operating expenses.

1. Understand your income statement

Your income statement is a financial report card that details your company’s:

Revenue
Expenses, and
Losses.

It’s limited to a specific period of time in order to show you an accurate picture of your net profit or net loss.

Income statements should show 5 things:

Total revenue (all money coming in)
Cost of goods sold (what it costs you to make your product or complete your service)
Gross profit (revenue – cost of goods)
Itemized expenses (all expenses including operating costs)
Net profit (gross profit – expenses)

For our purposes today—estimating operating costs—we’ll use information from sections 2 and 4, though every income statement will list/number this information differently.

2. Know the difference: Operating costs vs operating expenses

Before we jump into how to estimate operating expenses, we need to answer one question: What are operating costs vs operating expenses? The short answer is operating expenses are just one part of operating costs.

Here’s a simple formula:

Operating costs = cost of goods sold (COGS) + operating expenses

Now we can break down the rest.

3. What are operating costs?

Operating costs are every cost you incur to run your business—also known as any costs associated with revenue-generating activities. Operating costs do not include expenses related to investing or financing.

a. What are operating expenses?

Operating expenses are any costs a company generates that do not relate to the production of a product. They’re also called selling, general, and administrative (SG&A) expenses.

Operating expenses include:

Accounting and legal fees
Sales and marketing
Travel and entertainment
Research and development (non-capitalized)
Office supplies and software
Rent, maintenance, taxes, and utilities for non-production facilities
Wages and benefits for non-production workers
Insurance

b. What is the cost of goods sold (COGS)?

The cost of goods sold includes all expenses directly tied to the production of goods and services.

COGS include the cost of:

Materials
Labor
Production facility rental, utilities, insurance, and taxes
Benefits and wages for production workers
Equipment repair

c. Estimating operating costs

When it comes to estimating total operating costs, simply use the formula from above:

Operating costs = cost of goods sold (COGS) + operating expenses

4. Use your operating costs to make smarter choices

Now that you’re able to estimate operating expenses and calculate operating costs, put that information to work for you.

To make the best long-term decisions, look at your operating costs over months (and eventually years) so you can take note of trends that emerge. Then make strategic changes, ideally one at a time, so you can see what’s moving the needle.

A few examples of these changes could include:

Increasing the price of your product or service
Decreasing COGS by using cheaper materials
Reducing the time staff spends on administrative tasks so more work gets done in less time

While you’re estimating operating costs, be sure you take a look at how your company tracks employee time. Automated time tracking using a solution like TimeTracker can save you 30+ hours of administration every month without significantly increasing expenses. And if you’re not yet tracking employee time, take this opportunity to remedy that error.