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:

1. Total revenue (all money coming in)
2. Cost of goods sold (what it costs you to make your product or complete your service)
3. Gross profit (revenue – cost of goods)
4. Itemized expenses (all expenses including operating costs)
5. 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: 

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:

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. 

Try TimeTracker

TimeTracker will help your managers and employees track their time and attendance in seconds. They’ll be able to:

• Monitor hours worked to avoid unnecessary overtime
• View ‘work week’ and ‘payroll period’
• Reject or edit submitted entries before approving
• Approve time for one or all employees in seconds

And those are just a handful of the features that can help you significantly decrease your operating expenses. 

Learn more (and try it free for 14 days).

The post Operating Costs vs Operating Expenses: What They Are & Why They’re Important appeared first on eBillity.