What are operating expenses?

Published Thursday 23 July 2026

Table of contents

• What are operating expenses?
• Types of operating expenses
• How to calculate operating expenses
• Operating expenses vs. capital expenditures
• Operating expenses vs. non-operating expenses
• Why operating expenses matter for your business
• How to manage and reduce operating expenses
• Simplify your expense tracking with Xero
• FAQs on operating expenses

Key takeaways

• Operating expenses (opex) are the recurring costs of running your business day to day, and they directly affect your profitability and operating margin.
• Common operating expenses include rent, salaries, utilities, insurance, and marketing; understanding which are fixed and which are variable helps you plan and budget more effectively.
• Operating expenses are fully tax-deductible in the year you incur them, unlike capital expenditures, which are depreciated over time.
• Tracking and managing your operating expenses closely is especially important when revenue growth is slow, because tighter cost control protects your bottom line.

What are operating expenses?

If you run a business, you spend money just to keep it going each day. Those recurring costs are your operating expenses.

Operating expenses (opex) are the ongoing costs your business incurs through its normal, day-to-day operations. They include things like rent, salaries, utilities, and office supplies. These aren't one-off purchases or long-term investments; they're the regular expenses that keep your doors open and your team working.

On your income statement, operating expenses appear after gross profit. Your revenue minus cost of goods sold (COGS) gives you gross profit, and then you subtract operating expenses to arrive at operating income. This makes opex a key factor in understanding how efficiently your business runs.

Types of operating expenses

Operating expenses cover a wide range of costs. Here are some of the most common categories you'll encounter as a small business owner.

• Rent: payments for your office, retail space, or warehouse
• Salaries and wages: compensation for your employees, including benefits
• Utilities: electricity, water, internet, and phone services
• Insurance: business liability, property, and workers' compensation coverage
• Marketing and advertising: costs for promoting your products or services
• Office supplies: everyday items like paper, printer ink, and software subscriptions
• Professional services: fees for accountants, lawyers, and consultants

These costs generally fall into 2 categories: fixed and variable. Fixed operating expenses stay the same each month regardless of how much business you do. Rent and insurance premiums are typical examples.

Variable operating expenses change based on your business activity. Marketing spend and office supply costs, for instance, may rise during busier periods and drop during slower ones.

According to a Xero survey of over 1,000 business owners in the US and Canada, rent was the biggest operating expense for physical businesses, while marketing was the main cost for online businesses, with over 1 in 4 online business owners naming marketing as their largest expense.

How to calculate operating expenses

Calculating your operating expenses is straightforward once you know which numbers to use. There are 2 common approaches.

The first method uses your income statement. The formula is:

Operating expenses = total revenue - operating income - cost of goods sold (COGS)

The second method is to simply add up all your individual operating expense line items, such as rent, salaries, utilities, and marketing costs.

Here's a worked example using the first formula. Say your business had $500,000 in total revenue, $200,000 in COGS, and $150,000 in operating income. Your operating expenses would be:

$500,000 - $150,000 - $200,000 = $150,000

That $150,000 represents the total cost of running your day-to-day operations for the period. Tracking this figure over time helps you spot trends and identify where you might be overspending.

Operating expenses vs. capital expenditures

It's easy to confuse operating expenses with capital expenditures (capex), but they're treated very differently in your accounts and on your tax return.

Operating expenses are fully deducted in the year you incur them. They cover the ongoing costs of running your business, like rent, salaries, and utility bills. Capital expenditures, on the other hand, are purchases of long-term assets that provide value over multiple years. These are capitalized on your balance sheet and depreciated over their useful life.

For example, your monthly internet bill is an operating expense. But if you buy a new delivery van or a piece of manufacturing equipment, that's a capital expenditure. You won't deduct the full cost of that van in 1 year; instead, you'll spread the deduction across several years through depreciation.

Understanding this distinction matters for budgeting and tax planning, because each type of expense affects your financial statements differently.

Operating expenses vs. non-operating expenses

Not every business cost qualifies as an operating expense. Some fall outside your core operations, and those are called non-operating expenses.

Non-operating expenses include things like interest payments on loans, losses from selling assets, and lawsuit settlements. These costs aren't part of your everyday business activities, so they're reported separately on your income statement, below operating income.

The distinction matters because it gives you a clearer picture of how efficiently your core business runs. If your operating expenses are well controlled but your total expenses look high, the issue might be non-operating costs like heavy debt interest, not your day-to-day operations. Separating the 2 helps you (and potential investors or lenders) evaluate your operational performance on its own.

Why operating expenses matter for your business

Your operating expenses play a direct role in your profitability. The lower your opex relative to revenue, the higher your operating margin, and the more money your business keeps from each dollar of sales.

Operating expenses are also central to financial analysis. Lenders, investors, and accountants look at your operating expense ratio (opex as a percentage of revenue) to gauge how efficiently you're running things. A rising ratio over time can signal that costs are growing faster than your revenue, which may call for action.

From a tax perspective, the IRS allows you to deduct ordinary and necessary business expenses in the year you incur them. This includes most operating expenses like rent, salaries, utilities, and professional services. For a full breakdown of deductible business expenses, see IRS Publication 535.

According to Xero Small Business Insights, US small business sales growth averaged just 2.4% year-over-year in 2025, around half the long-term average of 5.5%. When revenue growth is sluggish, keeping operating expenses in check becomes even more important for protecting profitability.

How to manage and reduce operating expenses

Bringing your operating expenses down doesn't have to mean cutting corners. A few practical strategies can help you save money while keeping your business running smoothly.

• Negotiate contracts: review your leases, supplier agreements, and service contracts regularly, and ask for better rates or terms
• Automate processes: use software to handle repetitive tasks like invoicing, bank reconciliation, and expense tracking, so you spend less time on manual admin
• Review subscriptions: audit your software tools and recurring services; cancel anything you're not actively using
• Outsource selectively: for tasks like bookkeeping, payroll, or IT support, outsourcing can be more cost-effective than hiring full-time staff
• Track and categorize expenses: use accounting software to monitor where your money goes each month, making it easier to spot trends and cut unnecessary costs

Small, consistent changes add up. Even trimming a few hundred dollars from 2 or 3 expense categories can make a meaningful difference to your bottom line over a year.

Simplify your expense tracking with Xero

Keeping on top of your operating expenses is easier when your accounting software does the heavy lifting. Xero connects to your bank and automatically imports transactions, so you can categorize and reconcile expenses in real time instead of chasing receipts at the end of the month.

With customizable reports and dashboards, you can see exactly where your money is going, compare spending across periods, and spot cost-saving opportunities before they slip by. Xero also makes it simple to collaborate with your accountant or bookkeeper, giving them direct access to your financials so you can get expert advice without the back-and-forth.

Ready to take the guesswork out of expense management? Get one month free.

FAQs on operating expenses

Here are some frequently asked questions about operating expenses.

Is depreciation an operating expense?

Yes, depreciation is typically classified as an operating expense on the income statement. It represents the gradual reduction in value of a long-term asset, like equipment or vehicles, and is spread across the asset's useful life.

Is interest an operating expense?

No, interest on loans or debt is a non-operating expense. It's reported separately on the income statement because it relates to financing activities, not your core business operations.

What is the difference between COGS and operating expenses?

Cost of goods sold (COGS) covers the direct costs of producing or purchasing the products you sell, such as raw materials and manufacturing labor. Operating expenses are the indirect costs of running your business, like rent, utilities, and administrative salaries.

What is a good operating expense ratio?

A good operating expense ratio varies by industry, but generally, a lower ratio means your business is more efficient. Most small businesses aim for an operating expense ratio that leaves enough margin to cover debt, taxes, and profit.

How does the IRS treat operating expenses?

The IRS allows you to deduct ordinary and necessary business expenses in the tax year you incur them. This includes most operating expenses like rent, wages, utilities, and insurance, which reduce your taxable income for the year.