No matter how much money a business is bringing in, all companies have outgoings in the shape of operating expenses (OPEX). Find out more about operating expenses, right here.
What is the operating expense ratio?
The operating expense ratio is used to compare operating expenses to the income of a company. This ratio is also known as the OER, and it is a key metric for deciding how well a company is doing, not only due to the money it is successfully attracting, but in showing how it manages its operating expenses and money out.
Why are operating expenses important?
Operating expenses are just as important as the money a business has coming in. Even a successful business can be at risk if its operating expenses are too high. Investors will also be interested in this figure, as well as the operating expenses ratio. A high OER will usually drive investors off, as it suggests a business’s money management needs improving.
Operating expenses examples
The following are the most common operating expenses that businesses will incur:
Generally, these are fixed operating expenses that do not change regardless of business revenue i.e. even if revenue goes up massively, your property rental cost isn’t going to change.
Operating expenses can be reduced by looking for cheaper property if you are renting a space, or in dire cases, downsizing your team. Small businesses looking to grow can often fall into the trap of hiring new starters too quickly, which can increase your operating expenses much faster than it may grow your profits.
Cost of services vs operating expenses
Cost of services, also referred to cost of goods sold (COGS), cost of sales, or cost of revenue refers to all costs associated with performing services given to customers. These are listed separately to operating expenses on the income statement. OPEX is not directly connected to the services or goods sold, whereas COGS refers to the costs of sourcing, making, and supplying any goods or services.
What is the operating expenses formula?
To find out the operating expenses ratio for your business, use the following formula:
Operating Expense Ratio = Operating Expenses / Effective Gross Income
So, if your business had a gross income of $60,000 and total operating expenses of $7000 (made of $1000 rent, $500 insurance, $1000 utilities, and $4500 salaries) then you would divide the two:
$7000 / $60,000 = 0.11, or 11%
What is the ideal amount for operating expenses?
Generally speaking, the lower the OER, the better, but any operating expenses ratio up to around 75% is relatively healthy.
One thing to remember is that the operating expenses ratio does not take debt into account. The ratio is also only relevant to the time it is calculated, it does not reflect on-going trends, so it is advised that you re-work this formula multiple times throughout the year. You may also want to compare your operating expenses with those of other businesses in your industry, to see if your expenses are better or worse than the average.
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