Xero Operating Expenses

What Are Total Operating Expenses

The total operating expenses metric refers to the sum of all expenses incurred by a business in its day-to-day operations.
These expenses are necessary to keep the business running and typically include things like the cost of goods sold, administrative expenses, depreciation, amortization, rent, research and development expenses, insurance, maintenance and repairs, professional services, and others.

It’s important to note that the specific categories and expense types can vary depending on the nature of the business and industry.

How to Calculate Total Operating Expenses

To calculate the total operating expenses for a business, you need to gather the necessary financial information from the income statement.
Simply put, the total operating expenses are calculated by summing up all the expenses incurred in the ordinary course of business operations.

You can use this formula:

Total Operating Expenses = Direct Expenses + Indirect Expenses + Other Operating Expenses

Direct expenses are those that are directly associated with the production or acquisition of goods or services.
Indirect expenses are expenses incurred in support of the overall business operations but not directly tied to the production process.
Other operating expenses refer to any additional operating expenses that are not included in the direct or indirect expenses categories.

Now, let’s say a company saw these expenses during a specific time frame:

• Cost of goods sold: $200,000
• Administrative expenses: $100,000
• Depreciation and amortization: $20,000
• Rent: $15,000
• Research and development: $10,000
• Utilities and overhead: $25,000
• Maintenance and repairs: $5,000
• Insurance: $8,000
• Professional services: $12,000
• Other Operating Expenses: $7,000

To calculate the total operating expenses, we sum up all these expenses:

Total Operating Expenses = $200,000 + $100,000 + $20,000 + $15,000 + $10,000 + $25,000 + $5,000 + $8,000 + $12,000 + $7,000

This way, we find that the total operating expenses for this company are $402,000.

Keep in mind that this is a simplified example. In practice, the income statement and calculation of operating expenses will usually involve more line items and complexities.

What Is a Good Operating Expense Ratio

As a general rule of thumb, a lower operating ratio indicates better operational efficiency for the business.

But the ideal ratio varies across industries due to major differences in business models, market dynamics, cost structures, and similar factors.

For example, in the healthcare Industry, the total operating expense ratio varies depending on the type of healthcare provider (hospital, clinic, etc.) and the mix of services they offer. It usually ranges from 70% to 90% of total revenue.

For the financial services industry, the total operating expense ratio can be influenced by factors such as regulatory requirements, staffing levels, and technology investments. Here, it typically ranges from 50% to 70% of total revenue.

It’s important to note that these ranges are general estimates and cannot be applied to every business within each industry.

You should analyze your specific operating expense ratio in conjunction with other financial metrics and industry benchmarks to get a better understanding of performance.

How to Reduce Total Operating Expenses

Since total operating costs have a direct impact on a company’s bottom line, business owners are constantly testing out new strategies to try and identify potential opportunities to minimize them.

Over the years, we talked to some of the leading industry experts and compiled a list of several methods they use to reduce total operating expenses in their businesses:

• Occasionally outsource financial analysis: Even if you have world-class financial analysts working for you, outsourcing the analysis to external agencies and getting a fresh set of eyes can lead to some interesting discoveries. They might find some hidden opportunities that your team missed.
  Check out the expenses of your industry peers: Dig out industry benchmarks and reports to check out what expenses your competitors are seeing. Go through their financial KPIs and pinpoint any area you notice that they’re paying less than you are. Then, go through your available options to see if there’s a new opportunity to reduce those expenses, without jeopardizing quality.
• Set strict policy guidelines: Make your policy guidelines as simple as possible so your employees don’t overstep reimbursement boundaries. Once you eliminate the grey areas, you reduce the chance of overpaying for unnecessary expenses.

More resources to help you reduce total operating expenses:

• 9 Vital Small Business Financial Reports for Your Organization
• 4 Most Important Accounting Reports for Your Small Business
• Overcome Financial Reporting Challenges with These 6 Best Practices