As a business owner, it’s important to have a comprehensive understanding of OPEX (operating expenses). Explore the significance of operating expenses in greater detail with our simple guide, starting off with our rundown of the meaning of OPEX.
OPEX, which stands for operating expenses or expenditure, refers to the costs incurred by your business via the production of goods and services. It can include a broad range of expenses, including materials, labor, machinery, packaging, shipping materials, and so on.
Having a full understanding of your operating expenses is vital for crafting an accurate annual plan, and as such, it’s something you need to pay attention to when budgeting for production/delivery.
The difference between operating expenses and overheads
Operating expenses and overheads may sound similar, but they refer to very different things. In short, overheads are ongoing, whereas operating expenses stop when production stops. Examples of overhead expenses include things like utilities, rent, and insurance.
Another key distinction between OPEX and overheads is the fact that overhead expenses can be tweaked over time. If you negotiate a lease for a smaller workspace, for example, your overheads will go down as you’ll start paying less rent. By contrast, operating expenses are unavoidable, and are likely to increase as demand for your product or service increases.
OPEX vs. CAPEX
While you’re researching OPEX, you’ll probably come across another, similar term: CAPEX. There are a couple of important distinctions between the two concepts that you need to be aware of.
Essentially, CAPEX (capital expenses or expenditure) refers to purchases made by your company as an investment. This can include a broad range of purchases, including machinery/equipment, real estate, or improvements to your existing infrastructure.
So, whereas OPEX covers your company’s day-to-day expenses, CAPEX refers to major purchases that are used over the long-term.
When it comes to OPEX vs. CAPEX, it’s also important to remember that operating expenses are tax deductible, whereas CAPEX isn’t. This is one reason why businesses in the early stages might look to rent a property, rather than purchase it outright.
In addition, you should remember that incurring debt to fund OPEX is generally frowned upon, whereas the same practice is deemed acceptable when investing in CAPEX. This is because CAPEX investments are expected to make a return in the future, thereby offsetting any debt created by the initial purchase.
Furthermore, investors tend to prefer the security and asset-rich status that comes with a brand with larger investments (CAPEX).
Understanding the OPEX formula
Unsure which of your expenses count as OPEX, and which don’t? There’s a relatively simple way to find out. Imagine you needed to shut down production at your company. Think about which areas need to be brought to a halt. These are the expenses that fall into the OPEX category. To calculate your firm’s operating expenses, you simply need to add up all your operating costs. In addition, you should be able to find your operating costs listed on your income statement.
Once you’ve found your business’s OPEX figure, you can use it to work out your operating expense ratio (also referred to as your OPEX ratio). Essentially, this allows you to compare your total operating expenses with your net sales, which provides an indication of how well your company is able to reduce costs while generating sales. The OPEX formula you can use for calculating the OPEX ratio is as follows:
OPEX Ratio = Operating Expenses + Cost of Goods Sold (COGS) / Net Sales
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