Operating costs: Formula, how to calculate [with examples included]

Tracking and analyzing your business’s operating costs is essential for increasing efficiency and ensuring your business is making a profit. For example, many companies sign up for subscription services and don’t use them very often or forget they exist. Periodically auditing your operating costs can help you identify unnecessary spending. 

Be careful not to cut costs too severely. As you optimize your spending to minimize operating costs, keep an eye on your business’s long-term health, as changes that are too severe can reduce both productivity and profitability.

Let’s look at what operating costs are, how to calculate them, the different types, and examples to learn how to manage them:

• What are operating costs?
• How do you calculate operating costs?
• Operating cost categories
• Real-world example of operating costs
• Streamline your accounting and save time
• Operating costs FAQ

What are operating costs?

Operating costs are the day-to-day costs to keep a business running. Some of these costs are unavoidable, like fixed costs, and others change with an increase or decrease in production, such as variable costs. The third type has a base cost but increases with higher production—known as semi-variable costs. 

Operating costs may include:

• Rent
• Cost of goods sold (COGS)
• Utilities
• Depreciation
• Insurance
• Payroll
• Advertising

Operating costs appear in the income statement after your company’s gross income. Operating costs impact a company’s profitability. The more you can reduce your operating costs, the higher your profit margin will be. However, cutting operating costs too much can be risky, as it could decrease the company’s output, resulting in fewer sales.

How do you calculate operating costs?

To determine the operating cost, select a period from your income statement. Then, use the operating cost formula:

Operating costs = Cost of goods sold (COGS) + Operating expenses (OPEX)

COGS includes all the expenses that are directly associated with the production of goods or services. 

COGS includes the following expenses:

• Cost of raw materials
• Direct labor cost
• Rent of plant or manufacturing unit
• Wages
• Costs of repair
• Utility costs and taxes

Operating expenses (OPEX) include the selling, general, and administrative expenses of a business. These are the costs that you incur to conduct normal business operations that are unrelated to production. 

OPEX typically includes: 

• Advertising and marketing
• Administrative payroll
• Research and development
• Insurance premiums
• Office expenses

For example, if a company had a factory on one side of town and administrative offices on another side of town, the factory rent would be an operating cost, while the administrative office rent would be an operating expense. That’s because the employees in the administrative office do not contribute to the company’s production.

Operating cost categories

Generally, business operating costs are divided into three categories. These categories are fixed costs, variable costs, and semi-variable costs.

 Fixed costs

Fixed costs are the costs that do not change with the change in the level of output of goods or services. This means that such costs remain constant with an increase or decrease in the volume of output.

A common example of a fixed business cost is rent. If a company has to halt production, they still have to pay rent each month. Rent is a fixed cost because it occurs regardless of increases or decreases in the company’s activities.

Examples of fixed costs include:

• Salaries
• Rent
• Leases
• Insurance
• Property taxes
• Certain utilities (like trash removal)

As a business owner, you determine the fixed costs via contract agreements or cost schedules. Fixed costs only change when you enter into new contractual agreements or cost schedules. 

Fixed costs can be categorized as either direct or indirect:

• Direct fixed costs could include costs like direct labor or rent. 
• Indirect fixed costs may include depreciation, salaries, and office supplies. 

Your business has to pay fixed costs regardless of any specific business activity. When totaled up, fixed, variable, and semi-variable costs are the total costs of your business operations. 

Variable costs

Unlike fixed costs which are always the same, variable costs increase or decrease based on a company’s production. For example, a surfboard factory may double its staff to increase production just before summer begins and then return to normal staff levels in the fall. 

Gasoline is a variable cost for a restaurant that offers food delivery. If there are no requests for delivery orders, the cost of gasoline is zero. When several food delivery requests are made, the restaurant’s gasoline costs go up. When the demand for delivery drops, the spending on gasoline also goes down.

Examples of variable costs include:

• Direct and raw materials
• Packaging
• Utility cost
• Payroll
• Sales commissions

Large increases or decreases in a company’s output can lead to variable costs in categories like utility bills, payroll, or distribution. The per-unit variable cost of production remains constant for a given level of output, but the per-unit variable cost increases as the volume of output increases.

Likewise, the per-unit variable costs decrease with the decrease in the level of output. You can calculate the total variable cost of your business operations by multiplying the quantity of output with the variable cost per unit of output.

Semi-variable costs

The third type of business costs are known as semi-variable and are similar to fixed and variable costs. Semi-variable costs are variable because they increase with increased production but are also fixed because they still occur even when production pauses.

Examples of semi-variable costs include:

• Overtime pay for hourly employees
• Internet bill when using extra bandwidth
• Electricity costs when production is increased
• Sales commissions for a salaried salesperson

A common example of a semi-variable cost in business is overtime pay. A business will have a minimum cost for payroll that will increase when employees are needed to work overtime. The standard payroll cost is fixed while the overtime costs are variable.

A semi-variable cost is similar to a smartphone with a limited data plan. The monthly cost for the smartphone is fixed, but if the user exceeds their data limit, the cost increases and becomes variable. Semi-variable costs will have a base minimum cost that can increase with additional usage.

Real-world example of operating costs

Say a small manufacturer is looking to understand better how their profitability works. Its income statement includes the following for the last year: 

• Sales revenue of $225,000
• Cost of goods sold (COGS) of $75,000
• Salaries of $90,000
• Rent expenses of $10,000
• Advertising and marketing $4,000
• Insurance costs of $6,000
• Office suppliers of $5,000
• Interest expenses $1,000
• Tax expenses $2,500

The operating costs are COGS plus the operating expenses. Operating expenses include all of the above except the interest and tax expenses. So, for the manufacturer, the operating costs are $190,000, which is COGS of $75,000 plus the total operating expense of $115,000.

The company can then analyze its operating costs from period to period to see which costs can be reduced or eliminated.

Streamline your accounting and save time

Understanding and managing operating costs is an important part of running a business. If you don’t track and try to reduce your operating costs when needed, your profit margin may suffer. Easy-to-use accounting software like QuickBooks Online makes these costs apparent and helps you eliminate unnecessary expenses.