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What is operating cost?

Operating cost definition

The operating cost definition refers to expenses associated with the maintenance and administration of a business on a daily basis.

Also known as operational cost, it includes operating and overhead expenses, as well as the cost of goods sold. Common operating cost examples are rent, machinery, payroll services, utilities, uniforms and office supplies.

Note that the operating cost meaning should not be confused with that of operating expense. Commonly known as OPEX, operating expense is an ongoing cost for running a product, business, or system and does not include the cost of goods sold (such as materials and direct labour), or capital expenditures (such as machines or buildings).

The operating cost is deducted from revenue to calculate operating income and is reflected on a company’s income statement.

Where have you heard about operating costs?

Operating cost is a familiar term in business and of great importance to every company and investor as an indicator of performance and potential.

You may have heard the term when a large company releases its quarterly or annual financial statement. Such an event usually has a high media coverage by both online and offline sources, including financial newspapers, TV news reports and the internet.

Moreover, your investment manager or financial adviser may have recommended keeping your eye on the company's operating costs when evaluating its performance and making investment decisions.

What you need to know about operating cost.

When wondering what operating costs are, think about what it takes to have the staff necessary to sell and fulfil customer needs and keep the lights on in the office or factory. These types of expenses include rent and lease payments, office supplies, utility costs, bank charges and employee wages.

There may also be legal and accounting fees included in these numbers, as well as sales and marketing costs, entertainment costs and travel expenses. Every business should have this data categorised in its bookkeeping system in order to be able to easily run reports and financial statements.

Operating costs also account for the costs of making or buying a company's products and services. Often called the costs of goods sold (COGS), these may include direct material costs or repair costs of equipment.

For a company, operating costs typically fall into three broad categories:

  • Fixed costs, such as the rent of the building. These generally have to be paid regardless of what state the business is in – it never changes.
  • Variable costs, such as computer supplies, cell phone services, office products and payroll services. These may increase depending on whether more production is done, and how it is done.
  • Semi-variable, such as overtime labour. These costs represent a mixture of variable and fixed components. 

Operating costs are typically reflected on a company's income statement, which is recorded on a quarterly or annual basis. The formula for calculating the operating cost is as follows:

Operating cost = cost of goods sold + operating expenses

Investors can monitor how operating costs increase or decrease over time relative to a company's profitability as a way to evaluate the company's management. As with any financial metric, operating costs must be compared over multiple reporting periods in order to detect a particular trend.

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