What are Operating Costs?
Operating costs are the expenses that relate to the maintenance and administration of the operations of a company or business. The operating costs of a company include its direct cost of goods sold and its overall operating expenses. Therefore, a company’s operating costs include its salaries and wages, rent, overhead costs to raw material, and maintenance expenses.
As the name implies, the operating costs of a company exclude its total non-operating costs. These are expenses not related to the core operations of a company. For example, it may include expenses, such as interest on loans. By emitting these expenses from the total expenses of a company, users can better evaluate its performance.
Similarly, the operating costs of a company are necessary for calculating its operating income. The operating income is the earnings of a company after deducting its operating costs from its revenues. Usually, companies report their operating income on their Income Statements.
What is the formula for Operating Costs?
There are various methods that users can determine the operating costs of a company. All the information necessary to calculate it exists in its Income Statement. The most straightforward formula to determine operating costs is as below.
Operating costs = Revenues – Operating Income
This formula uses the prominent figures in a company’s Income Statement to reach its operating costs. However, there’s also another method to calculate it. It is as follows.
Operating costs = Cost of goods sold + Operating expenses
For this formula, users need to take a company’s cost of goods sold, sometimes called the cost of sales. After that, they need to find the total operating expenses, which would be the sum of all direct expenses. By adding these two figures, they can calculate the company’s operating costs.
Why are the Operating Costs critical?
Determining the operating costs of a company can be helpful for a company’s management and investors. For companies, the operating costs allow them to keep track of their profitability based on expenses they can control. It can help those companies in determining any inefficiencies in their processes and reduce their costs.
The operating costs are also critical because it excludes expenses that vary according to a company’s accounting policies. Therefore, it allows companies to focus on only their activities that generate revenues. Overall, the operating costs allow companies to reduce their costs to maximize profitability.
For investors, the operating costs of a company are of interest for the same reason. By neglecting costs that don’t come directly from the company’s operations, investors can make better decisions about their relationship with the company. Similarly, a company’s operating costs also allow investors to determine how much a company is spending on its operations.
While it’s best for companies to have the lowest operating costs possible, it can also be problematic. Low operating costs for a company may indicate poor productivity, which affects its profits. Similarly, decreasing the operating profits may increase short-term earnings. However, it may end up hurting the company in the long-term. Therefore, companies need to find a balance between the right operating costs for them.
The operating costs of a company include its direct costs related to its operations. It consists of a company’s cost of sales and other expenses that come directly because of a company’s operations. The operating costs of a company are critical for both the company and its investors.