Operating, same as pre-operating costs, are an integral part of everyday business operations, so we decided to present what they are and how businesses can reduce them.
Key Takeaways
- Operating costs are not related to the production of the goods or services that the business provides to customers and clients.
- Businesses divide operational costs into fixed and variable expenses.
- If the business owner reduces operating costs to the minimum, that practice will be reflected in the higher profit margin.
- Rent, labor, and supply are every business’s most significant expenses.
- Outsourcing some of the work to freelance workers can reduce business operating costs to a minimum.
What Are Operating Costs?
Operating costs are expenses that aren’t directly related to producing goods or services that businesses provide. They’re often called selling, general and administrative costs.
Operating costs have a significant impact when it comes to calculating whether a company makes a loss or profit. If the manager is able to reduce operating expenses, that will result in a higher profit margin for the business.
What Are The Two Main Types of Operating Costs?
The two main types of operating costs are fixed costs and variable costs.
Fixed costs
Fixed costs remain the same regardless of how much the company produces products or offers services. Fixed costs don’t reflect the productivity of a company.
These expenses usually are independent of the type of business as well.
For example, a company must pay rent for its store regardless of how successful the business is that month. Standard fixed costs are rent, property tax, insurance, and administrative expenses.
Variable costs
Variable costs fluctuate with a company’s productivity and are representative of a company’s productivity. Variable costs include the expenses of raw materials, production payroll, electricity and water bills, and extra production personnel hired during a busy month.
In addition, there is a minor category called semi-variable costs. These are fixed costs that become variable in specific situations. For example, if a company is exceptionally productive in one particular period, it may need to bear the cost of overtime wages.
Examples of Operating Costs
Rent
Rent cost is the expense a business bears to occupy a property for an office, retail space, storage space, or factory. Depending on the type of business, rent can vary drastically.
The ideal renting space is near a metropolitan area and close to transport lines and ports.
Rent will be a significant expense for a restaurant situated in an area with foot traffic, offices, and schools. But if a business is looking for a storage unit, it’s more convenient for the storage unit to be placed near a port or transportation lines.
Equipment
A business might not have to buy equipment every month, but equipment may need routine maintenance. Maintenance of some equipment may require a licensed professional, and that can be costly.
For example, an investor in opening a franchise will spend more on the working equipment than an entrepreneur that is starting an independent business venture.
This is due to the fact that franchisees must buy only from franchisor-approved work equipment suppliers, and owners of independent businesses can buy from everyone; even second-hand equipment is a possible option.
Payroll
Payroll is the compensation a business gives its employees for their work. It’s usually managed by the human resources department of a company.
Payroll can also refer to the list of a company’s employees and the compensation amount due to each. It’s a significant expense and is often tax-deductible.
Insurance
Business insurance protects businesses from losses that may occur during regular proceedings of the business.
A wide range of insurance packages is available for businesses, including employee-related insurance, property damage insurance, and legal liability insurance.
The cost of insuring a business depends on the potential risks the business can face, and it can vary from industry to industry.
Inventory costs
Inventory costs are the expenses incurred when managing the inventory or stocks in a product-based business.
There are three categories of inventory costs:
- Ordering costs: include purchase requisition, orders and invoicing, labor fees, and money transfer fees. Ordering costs are generally insignificant.
- Carrying costs: A business’s expenses when maintaining its stocks are called carrying costs. Carrying costs can include insurance taken out for the stocks, taxes related to the stocks, and the price for replacing perished stocks. Having a clear idea of your carrying costs is vital to making a profit.
- Stockout costs: Stockout costs represent any lost sales. Lost sales could include the inability to sell a product because it was defective. Loss of a sale can also be an item being out of stock and the customer purchasing the product from a different business.
Office supplies cost
These are expenses related to stationery, ink cartridges for printers and photocopy machines, light bulbs, and replacement of broken office supplies.
At present, most business office supply costs can be reduced with online work to a minimum, and that is due to the fact that stationery and printer usage are reduced with the use of digital technology benefits.
This, however, doesn’t apply to law firms as legal documents need to be printed out for court.
Utility costs
Utility costs include the electricity bill, water bills, internet connection bills, postal costs, sanitation and disposal charges, telephone bills, etc.
Expenses like electricity bills are rising due to increased usage of machinery and computers for doing everyday business tasks. Internet bills are also rising because businesses like banks and tuition institutions are starting to provide online services for convenience.
How Can a Business Reduce Operational Costs?
Keep an eye on operational costs.
When it comes to cutting business costs, it’s essential to know how much money is spent on different resources. Cutting funding to inventory and utilities can lead to poor products and services, which will turn into stockout costs because of customer dissatisfaction.
Cutting costs for office supplies is less likely to affect the quality of products and services, so entrepreneurs must focus on reducing them to the minimum possible.
Invest in smart technology to automate time-consuming tasks
Investing in better software and computers can reduce the workers needed for a particular task. Using smart switches can help reduce electricity waste during office hours by switching off unnecessary lights and air conditioners etc.
Go paperless
This can reduce office supply costs. The money spent on pens and pencils, ink cartridges, and copy paper can be drastically reduced by going paperless.
Switch to remote work
While this may not apply to every business, employees working from home can save a business a lot of money. Businesses can save on rent, utilities, office supplies, and travel costs by allowing employees to work from home.
Hire interns
Interns are individuals with low experience but can be valuable assets to a business. They are usually paid less than an employee.
Interns can be trained and, if they are deemed suitable, can be hired directly as employees when their internships end. This way, the business will save the cost to be spent on scouting and interviewing potential employees.
Consider hiring a freelancer.
Freelancers can cover services you don’t need on a regular basis. Freelancers can help you out during busy seasons, and businesses don’t have to bear the cost of health insurance, paid time off, and other benefits.
By outsourcing some of the work to freelances, the business is paying per task, and that is very convenient than hiring a full-time worker.
Summary
It is pretty simple to understand what are operating costs; however, the biggest task for entrepreneurs will be to understand how to reduce them. These expenses must be at the minimum possible because that practice will live more profit in the business owner’s pocket.