operating costs in business plan

Operating Costs: An In-depth Analysis of Business Expenses

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Operating Costs Definition

Operating costs refer to the expenses associated with the day-to-day functioning of a business, including salaries, rent, utilities, inventory costs, marketing, and other administrative expenses. They do not include costs related to debt, taxes, or investments in infrastructure or equipment.

Types of Operating Costs

In our exploration of operating costs, we find that these expenses break down into two main categories – fixed costs and variable costs. How a business manages these costs has significant implications for their overall profitability.

Fixed Costs

Fixed costs, as the name suggests, are expenses that remain constant regardless of the business's level of output or activity. These don't change with the volume of goods or services produced. Examples of fixed costs typically include rent for office space, salaries, insurance, and depreciation.

Say, for example, you run a small manufacturing unit. Your rent remains the same whether you manufacture one item or a hundred in a given period. These costs have to be paid, regardless of your business's sales performance. Thus, they're known as 'fixed.'

These expenses are a challenge because they need to be paid even when a business is not generating sufficient revenue. Therefore, a good understanding of your fixed costs allows for better planning and can help maintain profitability, especially during downturns.

Variable Costs

On the other hand, variable costs change in direct proportion to the level of production or business activity. These costs increase or decrease based on the volume of output.

Costs such as raw materials, electricity for manufacturing, direct labor costs, and shipping are considered variable costs. For instance, if you're producing more items in your manufacturing unit, you'll need more electricity and raw materials. Similarly, you might need less if you scale down production.

Variable costs present a different kind of challenge. If not managed well, an increase in these costs may lead to a decrease in profitability, even if sales are booming. Therefore, tracking and optimal usage of resources become crucial in keeping variable costs under control.

By understanding the difference between fixed and variable costs, it becomes easier to allocate resources, set appropriate pricing, and ultimately, improve profitability.

Calculating Operating Costs

In the process of calculating operating costs, organizations will generally utilize financial data segmented by operating hours, work shifts, fiscal quarters, or full years, among other time periods. There are several key components to take into account when calculating these costs.

Labor Costs

Labor costs often represent one of the larger expenses for many businesses. This component of operating costs includes all costs associated with employees, such as salaries or wages, benefits, payroll taxes, and any costs linked to recruiting and training new staff members.

To calculate labor costs, you'd take the total number of hours worked times the average wage, then add in the cost of benefits and other expenses. Remember to include all employees, from temporary hires, part-time employees, contractors, to full-time staff.

Material Costs

Material costs, which vary greatly between industries, are the expenses related to the physical goods needed for a business to operate efficiently. For manufacturing companies, this could include raw materials used in the creation of a product, while a restaurant would count the food they serve as part of their material costs.

When calculating this cost component, you sum up the cost of all materials consumed in your operating activities. Should your demand or prices fluctuate over the period you're looking at, you may need to calculate average costs or use other methods to reach accurate figures.

Overhead Costs

Overhead costs are the business expenses that are not directly linked to the production or selling of goods or services but are essential for the business to function. These include rent or mortgage payments, insurance, equipment and utility bills (electricity, internet, etc.), and depreciation and amortization of assets, among others.

Calculating overhead costs may seem tricky because they often compose a mix of fixed, variable, and semi-variable costs. A good practice is to strictly categorize these costs and then add them up for the specific time period.

By understanding and analyzing these various components of operating costs, an organization gives itself the power to improve its efficiency, increase profitability, and make more informed decisions. The structure for the calculation is simple: Labor Costs + Material Costs + Overhead Costs = Operating Costs. But learning to minimize and manage these costs brings in the real competitive edge.

Operating Costs and Pricing Strategy

Understanding operating costs is fundamental to creating an effective pricing strategy for any business. They represent the direct and overhead costs incurred to operate a business, and they impact pricing decisions significantly.

How Operating Costs Influence Pricing Strategy

In essence, a business aims to cover its operating costs and generate profit. Therefore, understanding the level of these costs can give a business the insight necessary to place a price tag on its products or services that not only covers these expenses but also leaves a margin for profit.

Every product sold needs to at least generate enough revenue to cover the fraction of operating costs attributable to its production and sale. If a business underestimates its operating costs, it may incorrectly set lower prices and will likely face difficulties trying to cover these costs, inevitably damaging profitability.

On the other hand, if operating costs are overestimated, prices may be set too high compared to competitors offering the same goods or services, which could push customers away. Thus, understanding the true operating costs helps a business set prices that are both profitable and competitive.

Operating Costs Effects on Profitable and Competitive Prices

The pricing strategy also should consider competitor pricing and the usual market value for the product or service. If your operating costs are significantly higher than your competitors, and consequently your prices are too, you may need to consider how you're operating and whether there are areas you can reduce costs.

While high operating costs challenge profitability, they can also provide opportunities. If a business can justify higher costs due to superior quality or unique aspects of its product or service, it could leverage these factors to justify a higher price point. This could potentially increase profits and set the product apart from competitors even with a higher price tag.

Overall, understanding the role of operating costs in determining prices helps businesses to set prices that adequately cover those costs, target a decent profitability margin and remain competitive in the market. The ability to accurately estimate and manage these costs is therefore vital for any successful business.

Operating Costs vs Capital Costs

Operating Costs and Capital Costs, though both significant for a business, serve different purposes and are treated differently in financial accounting.

Understanding Capital Costs

Capital costs are one-time expenditures that a company incurs when it buys assets that improve its operations for a long period, typically over a year. These costs, also known as capital expenditure or CapEx, could include expenses like purchasing a new property, upgrading equipment, or investing in technologies. Capital costs are considered an investment in the company's future performance and productivity.

Financial Accounting Treatment

In financial accounting, capital costs are not fully expensed during the purchasing year because their benefits extend over a long period. Instead, they are capitalized as an asset and then depreciated or amortized over their useful economic lives. This spreading out of costs allows a better match between expenditure and the income generated from these assets. It also reduces the tax liability in the first years of purchase as depreciation and amortization are tax-deductible.

Implications on Cash Flow

While capital costs have an immediate impact on cash flow – the purchase of an asset results in an outflow of cash – the impact on the income statement is gradual and spread across years. This is demonstrated in the cash flow statement, where the purchase of an asset falls under investing activities.

Effect on Profitability

Initially, capital costs may not seem to have a significant impact on profitability. However, as the asset depreciates, each year's fraction of the cost is recorded as depreciation expense, which reduces net income and, thus, profitability.

Operating Costs Implications

Operating costs or OpEx, on the other hand, pertain to the day-to-day running costs of a business. These costs, like rent, salaries, utilities, and maintenance, are inevitable yet recurring. Unlike CapEx, operating expenses are fully tax-deductible in the year they are incurred.

Immediate Financial Impact

Operating costs have a direct impact on a company's bottom line. A company's operating income is determined by subtracting operating costs from gross profit. Therefore, a company with lower operating costs will often have higher profitability.

Cash Flow and Profitability

The cash flow is affected immediately by any changes in operating costs. If operating costs increase for any reason without a corresponding rise in income, cash flow will decrease. Similarly, profitability will be directly affected – higher operating costs will reduce profitability unless offset with increased revenues or decreased other expenses.

Thus, while both operating and capital costs play essential roles in a company's financial position, how accountants treat them and their effects on cash flow and profitability provide a clear distinction between the two.

Operating Costs and Budgeting

Knowledge of operating costs is an essential aspect when it comes to the creation of accurate budgets and financial forecasts. By understanding the expenses related to the day-to-day operations of the business, management can make informed budgetary decisions. This knowledge aids in a realistic representation of the company's financial future.

Role in Predicting Future Spending

Foreknowledge of operating expenses allows a business to anticipate future spending accurately. By analyzing historical data and trends, a company can project the likely cost of its operations going forward. This projection then forms a basis for budgeting and aids in the financial forecasting. This allows businesses to manage resources efficiently and strategic decision making.

For instance, if a company can predict a rise in a particular cost, such as energy, they can budget accordingly or look into more efficient alternatives to maintain profit margins.

Strategic Decision Making

Moreover, knowledge of operating costs informs strategic decision making. By understanding the cost implications of each decision, management can optimize operational efficiency, cut unnecessary costs, and allocate resources more effectively.

For example, suppose operating costs are high due to an underperforming sector in the business. In that case, the company may decide to discontinue that arm of the business or find ways to increase its efficiency. Similarly, if operating costs are low in a particular area indicating high profitability, the business might choose to invest more heavily in that sector.

In summary, a thorough understanding and effective management of operating costs can enable a business to plan and execute better financial management strategies. This, in turn, leads to better decision making, increased profitability, and reduced financial risk. Building this understanding is a crucial step towards long-term financial stability for any company.

Operating Cost Ratios

Operating cost ratios are financial tools used to measure the efficiency of a firm's expenditure. These ratios compare specific operating costs to company revenue, offering insight into how well the firm is managing its expenses, generating profits, and achieving efficiency.

One common type of operating cost ratio is the Operating Expense Ratio (OER). This ratio demonstrates the percentage of a company's revenues consumed by the operating expenses – the day-to-day costs of running a business, excluding cost of goods sold (COGS) and depreciation. This ratio is typically shown as a percentage, and a lower ratio is generally preferable, as it indicates the business is spending less to earn each dollar of revenue.

The formula for OER is as follows:

[ OER = \frac{Operating \ Cost}{Net \ Sales} \times 100 ]

Suppose a company has operating costs of $500,000 and net sales of $1,000,000. The OER would be 50%. In other words, the company is spending half of its revenue on operating expenses.

Firms typically aim to decrease their OER over time, as a lower ratio can point to managerial efficiency and effectiveness. However, what constitutes a 'good' or 'bad' ratio can vary greatly by industry, so it's advisable to compare a company's OER to others in the same sector.

Variable Expense Ratio

Another important type of operating cost ratio is the Variable Expense Ratio. This measures the relationship between a company's variable costs – expenses that change with the level of output – and its sales. This ratio helps firms understand how changes in the volume of operations will affect profitability.

These cost ratios offer valuable information about a company’s ability to control costs, drive growth, and maintain profitability. Savvy investors often scrutinize these ratios when considering potential investment opportunities. After all, a business that fails to keep its operating costs in check may struggle to turn a profit, which could adversely affect the return on investment.

Operating Costs and Sustainability

Moving onto the implications of operating costs on a company's sustainability, it is essential to realize that strategic management of these costs can not only improve a business’s financial position, but also contribute favorably towards the environment.

Impact of High Operating Costs

When operating costs run high, it tends to affect the sustainability of a business. High costs can squeeze profit margins and make a business less competitive in the long run. In extreme cases, it can threaten the company's survival in the market. Therefore, managing these costs effectively often equates to enhancing the business's sustainability.

Cost-Saving through Energy Efficiency

One of the approaches to manage operating costs involves optimizing energy usage within the organization. Energy costs form a significant portion of operating expenses for many businesses – from utilities like electricity, gas, and water to the fuel consumed for company vehicles and machinery.

By investing in energy-efficient technologies or remodeling business processes to reduce energy waste, a business can effectively bring down its operating costs. For example, replacing conventional equipment with energy-saving alternatives, implementing auto-shut programs in computers to save electricity, or using energy management systems can aid in maintaining the concern for sustainability while also reducing costs.

Reducing Waste for Cost-Efficiency

Similarly, focusing on waste reduction can also contribute to cost savings. Waste not only implies physical materials that a company might be disposing of but also refers to inefficiencies in business processes.

This could mean anything from excessive use of raw materials to inefficiencies in labor utilization. By eliminating these wastes, a business can significantly lower its operating costs. Incorporating lean methodologies or using just-in-time inventory management are a few examples of how companies can reduce waste.

While the above initiatives center around lowering operating costs, they also enhance a business's environmental sustainability – a critical aspect in today's world dominated by concerns for climate change. Therefore, by considering the implications of operating costs for sustainability, businesses can achieve a double win by saving money and contributing to a healthier planet.

Operational Cost Management Strategies

Cost control.

Cost control refers to the systematic efforts made by businesses to reduce their expenses. This can be done in various ways. Some companies choose to streamline their operations, eliminating redundancy and improving efficiency. For example, they may consolidate roles or departments, or invest in technology that automates certain processes.

Others may renegotiate with suppliers for lower prices, or seek alternatives that provide similar quality at a reduced cost. Cutting unnecessary expenses and finding ways to reduce the costs of essential operations are fundamental components of a successful cost control strategy.

Process Improvement

Process improvement involves identifying, analyzing, and enhancing existing business processes within an organization for optimization and to meet new quotas or standards of quality. This often involves a systematic approach which follows a specific methodology such as Lean or Six Sigma.

The aim is to minimize waste without sacrificing productivity. This might mean streamlining communication, minimizing delays, reducing errors, or automating tasks. While the implementation of process improvement can initially be costly or time-consuming, the long-term savings in increased efficiency and reduced waste can greatly outweigh the investment.

Strategic Outsourcing

Strategic outsourcing is another often-used operational cost management strategy. This involves delegating certain non-core tasks or functions of the business to external agencies or specialists. These functions could range from IT services, accounting, customer service, or manufacturing processes.

Outsourcing can save a company money by negating the need for investment in resources or staffing for these tasks. It also allows the business to focus its resources (including time and manpower) on its core competencies, thus potentially improving overall performance and profitability. However, businesses must be careful to maintain control and oversight of outsourced processes to ensure quality and efficacy.

Each of these strategies has its own advantages and potential pitfalls, and may not be suitable for every organization. Therefore, businesses should carefully evaluate which strategies align with their unique needs, goals, and capacity before implementing them.

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Operating Expenses Defined: A Business Guide

Understanding how much money it takes to keep a company running is critical to the viability of all organizations. As operating expenditures increase, profitability decreases. Therefore, by being aware of and proactively mitigating the cost of operations, businesses have the potential to better control costs and improve their financial health.

What Are Operating Expenses?

Operating costs are expenditures directly related to day-to-day business activities, excluding the processes involved in manufacturing a product or delivering a service. Examples include rent, travel, utilities, salaries, office supplies, maintenance and repairs, property taxes and depreciation (see below for a more comprehensive list).

Operating vs. Non-Operating Expenses

A company’s operating expenses, sometimes called OpEx, are reflected in its income statement. Along with non-operating expenses, they help businesses calculate their profitability. Non-OpEx are expenditures indirectly related to operations that are the result of financing or investing activities, like interest payments on loans.

Operating (and non-operating) expenses can be fixed — unaffected by changes in production volume or service delivery — or variable, meaning they fluctuate in proportion to the changes in volume or delivery. While rent and salaries are examples of fixed OpEx, fuel and sales commissions are variable ones.

Operating Expenses vs. COGS

Operating expenses are different from the cost of goods sold (COGS) , which are the direct expenses a business pays to purchase or manufacture its products. COGS can be difficult to calculate depending on the complexity of the business and what it sells. In the simplest of terms, COGS include the beginning inventory plus inventory purchases minus the ending inventory. This formula includes the cost of purchasing the items, inbound freight, manufacturing (including labor), modification and packaging.

Capital Expenses vs. Operating Expenses

Unlike COGS and OpEx, capital expenses do not show up on the company’s income statement. Capital expenses, or CapEx, are one-time expenditures of tangible or nontangible assets that are reflected on a company’s balance sheet. These assets usually have a lifespan of one year or more and bring longer-term value to the business.

While capital expenditures are deductible, the deduction occurs over a period of time, rather than immediately. Those deductions happen through processes called depreciation and amortization . Note: In some cases, for certain asset categories, 100% first-year depreciation is allowed.

Key Takeaways

• Every organization has operating expenses that come with running a business and make it possible to sell goods or services.
• Compiling these costs helps organizations measure profitability and related numbers, like operating profit margin.
• By keeping a close eye on operating expenses, finance teams can identify outliers and trends that could reveal opportunities to reduce expenses without sacrificing product or service quality.
• Accounting software makes it much easier to calculate and track operating expenses and related metrics.

Operating Expense Explained

Having a clear picture of OpEx, COGS and non-OpEx is crucial to figuring out whether your business is profitable. There is no hard-and-fast rule on the ideal percentage of operating costs relative to revenue. It will differ depending on the business model, industry and the business’s maturity. But as a general rule, keeping operating costs under control and selling more of your products or services creates more free cash flow for the business, which is a good thing.

What Are Operational Activities?

Operating costs are the result of a company’s operating activities, or activities directly related to selling products or services to customers. Employee travel, marketing campaigns and repair of key equipment are all examples of operational activities.

On the cash flow statement , operating cash flow measures the cash coming into and out of the business from these operating activities. Cash comes in, for instance, from the sale of goods or services, and cash flows out to pay employees. Other classifications on the cash flow statement, like investing and financing activities, are considered non-OpEx.

What Is Included in Operating Expenses?

Operating costs, which include many of the expenses necessary to keep a business on its feet, consist of a wide array of expense categories. Here are 11 examples of these expenditures, which are related to various areas of a business’s core operations:

Office Supplies. These are items that are consistently used by office staff or require regular replenishment such as printer paper, invoices and sales receipts, staplers, pens, janitorial cleaning supplies and USB flash drives.

Depreciation. This refers to fixed assets bought by a company that depreciate in value over time. Assets that depreciate include warehouse equipment and machinery, furniture, computer equipment, delivery vehicles, buildings and store displays.

Advertising. Advertising includes any money spent on marketing the company. For example, business cards, social media, brochures, websites, and TV, print and digital campaigns.

Property Tax. These are real estate taxes that vary based on the assessed value of a property.

Inventory. Any expenses related to ordering and storing inventory in preparation for sale fall under operating expenses. For example, transportation and delivery, raw materials, manufacturing overhead, storage and labor costs are all inventory expenses.

Rent. This includes any costs associated with utilizing a location or property, unowned by business, for factory, storage, office or retail space. Within the real estate industry, the operating expense ratio (OER) is a metric used to compare the costs associated with operating properties with the revenue that said properties generate. Lower OERs are preferable and indicators of increased profitability as they suggest that less of the property’s income is going toward OpEx.

Payroll. Any administrative expenses related to employee wages, benefits and payroll taxes are part of OpEx.

Maintenance and Repairs. This refers to all necessary and unavoidable upkeep expenses incurred to keep items in working order. This includes fixing and replacing broken equipment items, painting and the costs of cleaning and inspecting business structures.

Utilities. Utilities include business expenses from public services such as water, electricity, internet, telephone, sewage, heating and waste disposal.

Insurance. This is the money businesses pay to purchase an insurance contract and the monthly unpaid premium costs associated with said contract.

Travel. Travel expenses incurred by a company that go toward reimbursing all business-related travels are part of OpEx.

Importance of Operating Expenses

Operating expenses are necessary to run any business. But, if they exceed the company’s total revenue, the company will not make any profit. With that in mind, costs associated with people, energy, transportation and travel are four types of operating expenditures companies can examine for cost-saving opportunities when they have a clear view of these expenditures.

How to Calculate Operating Expenses

Operating costs vary from one organization to another. Some companies have expenses that others don’t have to worry about, simply due to the nature of their business. Keeping that in mind, here’s a general formula for calculating operating costs:

Operating Expenses = Payroll/Wages + Sales Commissions + Marketing/Advertising Costs + Rent + Utilities + Insurance + Taxes

Businesses can then use their OpEx, COGS and non-OpEx to measure profit. Start with this simple formula from the U.S. Small Business Administration:

Sales – Cost of Goods Sold = Gross Profit – Overhead = Net Profit

While that formula is pretty straightforward, it’s not always immediately obvious whether, for instance, a transportation-related cost should be placed under COGS or OpEx.

COGS for a manufacturer, for instance, includes every cost associated with buying materials, freight costs to get those supplies to your warehouse or plant, expenses to make the product, modifications and packaging. That number is subtracted from the ending inventory to arrive at the COGS. (Note that IFRS and U.S. GAAP accounting standards use different methods to get COGS.)

The next step is to subtract COGS from sales to get the gross profit. This is where OpEx come into play. Once a company subtracts operating expenses from gross profit, it has its net profit.

Example of Operating Expenses

Take the ice cream shop Dig Dog Ice Cream as a simple example of this calculation. Dig Dog sells $200,000 worth of ice cream annually. The COGS includes the cones, ice cream and paper wrappers minus all of the supplies that weren’t used, amounting to $75,000. Operating costs include $2,000 in utilities, $10,000 in rent, $40,000 in salaries, $1,000 depreciation of the freezer and $2,000 for business insurance. There are no non-operating costs. That would make its net profit $70,000. (See the calculation below.)

$200,000 – $75,000 (COGS) = $125,000 (gross profit) – $55,000 (overhead) = $70,000 (net profit)

Operating Expenses on an Income Statement

Below is an income statement template provided by the U.S. Small Business Administration with a detailed list of many common operating expenses. (See highlighted section.)

This automated form is made available compliments of CCH Business Owner’s Toolkit

How to use operating expenses.

Knowing the total amount of operating costs helps businesses calculate profit and another valuable number: operating income, which is also referred to as earnings before interest and taxes (EBIT). How operating income changes over time will help businesses and potential investors determine whether it’s an efficient operation.

Operating Income = Gross Profit – Operating Expenses

Once a business knows its OpEx, it can use more complex formulas that lend insight into overall profitability, such as operating profit margin.

Operating Profit Margin = EBIT / Sales Revenue x 100

The higher the operating profit margin percentage, the more profitable the business.

What’s more, increasing sales without a significant increase in operating costs is crucial to growing profits. That’s why understanding OpEx is helpful, as finance teams can drill into expense line items to see outliers and trends and then look for ways to reign those in.

How to Cut Operating Costs

Research suggests that a 1% decrease in operating costs can increase profitability up to 10 times more than a corresponding increase in revenue, per Capgemini. With a clear view of operating costs, you can identify areas that appear too costly, then break out and examine them to find opportunities for cost savings.

Here are a few common ways to reduce operating expenses:

• Review utility bills — have they gone up over time? Look for energy-efficient investments, such as motion-sensor lights or HVAC upgrades.
• Evaluate options for internet/cable and insurance providers. See if another vendor offers a more competitive price.

Improve Expense Management Efficiency

How Accounting Software Helps Calculate Operating Expenses

To automate the process of tracking, recording and classifying expenses, most businesses turn to accounting software . The first step in the U.S. Small Business Administration’s list of “Ten Basic Bookkeeping Steps” is to purchase accounting software, which is ahead of opening a separate business checking account, reconciling that account and even tracking sales.

Accounting and financial management software are essential for monitoring revenue and expenses, generating financial reports and tracking other metrics that ensure the financial health of the business. Automation reduces errors borne of manual data entry and makes a time-consuming process much more efficient.

Above all, such a system will help a business generate accurate financial statements and reports that comply with U.S. GAAP and IFRS accounting standards.

Operating expenses are a gold mine of information that businesses can examine to reduce costs and drive efficiency across their organization. Once companies realize the sheer value of deeply analyzing and organizing their operational expenses, they can work toward reducing them while maintaining product prices and quality and increasing profitability.

Operating Expenses FAQs

What is included in the operating expenses?

Operating expenses are any costs incurred through daily business activities that don't fall under cost of goods sold. Variable operating expenses, such as packaging or shipping costs, fluctuate depending on the volume of an activity or the occupancy rate of a property. Conversely, fixed operating expenses, such as salaries or mortgage payments, remain consistent, as they are not influenced by volume or occupancy.

What are examples of operating expenses?

Common operating expenses for a company include rent, payroll, travel, utilities, insurance, maintenance and repairs, property taxes, office supplies, depreciation and advertising.

What are the categories of operating expenses?

Operating expenses can be broken down into three categories: office, compensation and sales- and marketing-related expenses. Office-related expenses come from typical office settings, and often include things like office supplies, property taxes, rent and insurance. Compensation-related expenses consist of payroll, employee benefits, sales commissions and pension plans. Finally, marketing- and sales-related expenses are directed toward all advertising materials, travel and entertainment.

What is not included in operating expenses?

Non-operating expenses are incurred outside of everyday business activities and related to financing or investing activities. Examples of non-operating costs include obsolete inventory charges, lawsuit settlements, losses on investments, damages caused by natural disasters and fires, restructuring costs and interest expenses. Any costs related to making goods or delivering services are also not part of OpEx.

Financial Management

What Are Capital Expenditures (CapEx) & Why Are They Important?

In accounting, a capital item is any asset, from real estate to office furniture to company vehicles, that’s carried on the balance sheet and depreciated over a set period of time…

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Operating Expenses: A Comprehensive Guide to Business Cost Management

• Banking & Finance
• Bookkeeping
• Business Operations
• Starting a Business

Operating expenses, commonly known as OpEx, are the costs that a business incurs through its normal operations. These expenses are essential for analyzing a company’s operational performance and efficiency. Understanding the various components of operating expenses is crucial for businesses to manage their costs and determine the impact they have on overall performance.

Examples of operating expenses include rent, equipment, inventory, marketing, payroll, accounting fees, insurance, legal fees, office supplies, maintenance, and repairs. These costs can be fixed (such as rent) or variable (like marketing budgets), and can be either tax-deductible or non-deductible. It is essential to differentiate operating expenses from capital expenditures (CapEx), which are investments in long-term assets that are not expensed through regular business operations.

Managing operating expenses is crucial for businesses to maintain profitability and scalability. By calculating the costs associated with day-to-day operations, companies can make informed decisions on how to allocate resources effectively, identify areas for improvement, and evaluate the impact of operating expenses on their financial performance.

Key Takeaways

• Operating expenses are the costs incurred through regular business operations and are essential for analyzing a company’s efficiency.
• Examples of operating expenses include rent, payroll, insurance, and marketing, which can be fixed or variable costs.
• Proper management and calculation of operating expenses are crucial for maintaining profitability and understanding their impact on business performance.

Understanding Operating Expenses

Definition and significance.

Operating expenses ( OpEx ) are the necessary costs a business incurs for its day-to-day operations. They play a critical role in assessing a company’s financial health and operational efficiency. Some common examples of operating expenses include:

• Marketing and advertising
• Office supplies
• Maintenance and repairs

Operating expenses are crucial in determining a company’s net income. They appear on the income statement and are deducted from the revenue to calculate the operating profit. A careful analysis of operating expenses can help businesses identify inefficiencies and make informed decisions to minimize unnecessary costs, thereby increasing their profitability.

Operating Expenses vs. Non-Operating Expenses

While operating expenses are related to a company’s primary business activities, non-operating expenses do not directly contribute to generating business revenue. Non-operating expenses are associated with events or transactions that occur outside the regular course of business. Examples of non-operating expenses can include:

• Interest payments on loans
• Losses from the sale of assets
• Lawsuit settlements

Non-operating expenses are also recorded on the income statement, but they occur below the line that separates operating income from non-operating income. This distinction is essential for understanding a company’s core business performance, as non-operating expenses do not reflect the cost of producing goods or rendering services. By comparing operating expenses with non-operating expenses, financial analysts and investors can obtain a clearer picture of a company’s overall financial standing and make informed judgments about its potential growth and viability.

Components of Operating Expenses

Operating expenses are the costs a company incurs to keep its business running, excluding costs directly tied to production. In this section, we will discuss various components of operating expenses.

Rent and Utilities

One significant component of operating expenses is rent . Companies often need to lease office space or land to run their business operations. Along with rent, businesses also need to pay for utilities such as water, electricity, and gas. These costs are necessary to maintain a functional working environment and facilitate daily operations.

Wages and Salaries

Another essential component is employee compensation, which includes wages and salaries . Wages are typically paid hourly, while salaries are a fixed amount paid for a specific job role. These expenses form a critical part of a company’s operational costs and directly impact their ability to attract, retain, and motivate skilled and experienced employees.

Supplies and Equipment

Companies need various supplies and equipment to run their daily operations. This may include items like office supplies (e.g., paper, pens, staplers), technology (e.g., computers, printers), and industry-specific equipment. These items have a direct impact on employee productivity and work quality.

Insurance and Maintenance

Insurance plays a crucial role in protecting a business from potential risks such as property damage, theft, and liability claims. Companies are required to carry various types of insurance, depending on their industry and location. In addition to insurance, businesses also need to allocate funds for regular maintenance and repairs. This helps ensure that their offices, equipment, and other essential assets remain in optimal condition.

In conclusion, understanding the components of operating expenses is crucial for businesses to effectively manage their finances. A clear insight into these costs helps businesses make informed decisions and implement strategies to optimize their resources and drive growth.

Managing Operating Expenses

Budgeting and monitoring.

Operating expenses are the costs incurred by a business for its operational activities. They include both variable costs, which change depending on the volume of goods or services produced, and fixed costs, which remain constant regardless of output. Efficient management of operating expenses is crucial for maintaining a company’s financial health and achieving its desired profit margins.

It is important for businesses to create a budget and carefully monitor their operating expenses. The budget should clearly outline the anticipated variable costs, such as the cost of goods sold (COGS), as well as the fixed costs like rent and salaries. This process allows companies to track their spending and compare it with their actual performance. By continuously monitoring these expenses, businesses can identify areas where they are overspending or where inefficiencies may be occurring.

Cost Reduction Strategies

Implementing cost reduction strategies can help improve a company’s efficiency and overall financial health. Here are a few potential strategies for reducing operating expenses:

• Process optimization: Streamline operations, such as production processes or administrative tasks, to increase the efficiency of the business.
• Outsourcing: Evaluate whether it is more cost-effective to outsource certain tasks, like payroll or IT support, to external service providers.
• Energy efficiency: Implement measures to reduce energy consumption, like using energy-efficient lighting or equipment, and monitor utility costs.
• Negotiating contracts: Re-evaluate contracts with suppliers, vendors, or service providers for better terms as the business grows.
• Employee training: Train employees for increased efficiency and productivity by offering opportunities for skill development and ongoing training.

By successfully managing operating expenses, businesses can increase their gross profit and maintain a strong financial position. Implementing a thorough budgeting and monitoring process, along with evaluating cost reduction strategies, can contribute significantly to a company’s overall success.

Calculating Operating Expenses

Operating expense formula.

To calculate operating expenses, sum up all the costs incurred during regular business operations that are not directly related to the production of a product or service. These expenses differ from the cost of goods sold (COGS), which are the costs associated with producing the goods or providing the services. Some common components of operating expenses include:

• Sales commissions
• Advertising expenses
• Salaries and wages
• Depreciation

The formula for calculating operating expenses is as follows:

Operating Expenses = Sales Commissions + Advertising Expenses + Salaries + Depreciation + Rent + Utilities

It’s essential to accurately calculate operating expenses to assess the financial health of a business and its profitability.

Ratio Analysis

Operating Expense Ratio (OER) is a key financial metric used to evaluate a company’s efficiency in controlling its operating expenses. It measures the proportion of a company’s revenue spent on operating expenses. A lower OER indicates that a company is managing its expenses efficiently and generating higher profits, while a higher OER suggests that the company has little control over its operating expenses.

The formula for calculating the operating expense ratio is:

Operating Expense Ratio = Operating Expenses / Net Sales

To better understand a company’s financial health, it’s important to analyze this ratio over time and compare it with industry benchmarks. Be aware that the ideal OER may vary depending on the industry and the size of the company.

In conclusion, calculating operating expenses and analyzing the operating expense ratio are essential tools for assessing a company’s profitability. By closely monitoring these metrics, businesses can make informed decisions to control expenses and maximize profits.

Impact on Business Performance

Profit margins and operating income.

Operating expenses significantly influence a business’s performance by directly impacting profit margins and operating income. These expenses comprise the day-to-day costs required to keep a business running, such as salaries, rent, advertising, and maintenance costs. They play a critical role in determining a company’s financial health and profitability.

One key metric to assess a business’s performance is its operating profit margin, which is calculated as follows:

Operating Profit Margin = Operating Income / Total Revenue

Operating Income is derived by subtracting Operating Expenses from Gross Profit . A higher operating profit margin indicates greater efficiency in managing operating expenses.

Businesses should continuously monitor and optimize their operating expenses to improve profitability. This can be achieved through cost reduction strategies, efficient resource allocation, and streamlining processes.

Investment and Financing Decisions

Operating expenses also impact investment and financing decisions. A prudent understanding of different cost components and their relationship with operating income can provide valuable insights into a company’s ability to invest in growth opportunities or access financing options.

For instance, a business with high operating expenses may be less attractive to investors and lenders as it could struggle to maintain adequate cash flows. On the other hand, a company that effectively manages its operating expenses can demonstrate financial stability and be better positioned to attract investment and financing.

Investing in cost-effective technologies, improving operational efficiency, and controlling labor costs can help a business strengthen its financial position and enhance its appeal to investors and lenders.

In summary, operating expenses play a pivotal role in impacting business performance, profitability, and financial decision-making. By effectively managing these expenses, a business can safeguard its bottom line and maintain a healthy financial standing.

Tax Considerations of Operating Expenses

Deductible business expenses.

When running a business, it is important to understand the tax implications of your operating expenses, as they can have a significant impact on your bottom line. In general, necessary and ordinary expenses incurred during the regular course of business operations are considered deductible business expenses . These include but are not limited to:

• Property taxes

Keep in mind that capital expenditures , such as purchasing equipment or a building, are not considered operating expenses and are treated differently for tax purposes. They are usually depreciated or amortized over a period of time, rather than being fully deductible in the year the expense is incurred.

Tax Planning Strategies

There are several strategies that can be used to optimize the tax benefits of operating expenses. Below are a few common tactics:

• Timing of expenses : Consider the timing of certain expenses to maximize tax deductions in a specific year. For instance, if you anticipate higher income in the current year, you might want to prepay some expenses to reduce your overall tax liability.
• Combining expenses : In some cases, combining certain expenses can lead to improved tax benefits. For example, if legal fees are incurred for both operating and capital expenditures, you might want to allocate them appropriately, so that a portion can be deducted as a necessary business expense.
• Proper documentation : Maintain accurate records of all your expenses, as it is essential for tax planning and compliance. This includes retaining receipts, invoices, and any other documentation that demonstrates the purpose and necessity of each expense.

By understanding the tax implications of operating expenses and incorporating appropriate tax planning strategies, businesses can make informed decisions about their finances and potentially reduce their overall tax burden.

Operating Expenses in Different Industries

This section will discuss operating expenses in various industries, focusing on the Retail and Manufacturing, and Services and Technology sectors.

Retail and Manufacturing

In the Retail and Manufacturing industry, operating expenses mainly consist of the following:

• Cost of goods sold (COGS) : This includes the cost of raw materials, manufacturing labor, and production overheads.
• Rent and utilities : Physical store maintenance, warehousing costs, and utility bills are vital expenses for both retailers and manufacturers.
• Wages and salaries : Employee compensation, including both hourly wages and salaried staff, make up a significant portion of operating expenses.
• Advertising and marketing : Retailers spend a considerable amount on promotional activities such as print and digital ads, in-store promotions, and display arrangements.
• Inventory management : Managing the inventory levels, transportation, and storage of products also contribute to operating expenses.

Services and Technology

In the Services and Technology industry, the following operating expenses are typical:

• Research and development (R&D) : Both service and technology companies allocate resources toward R&D to maintain a competitive edge and drive innovation.
• Salaries and wages : Employees in this sector generally receive higher compensation due to specialized skills, leading to increased operating expenses.
• Office rent and utilities : Service and technology firms often rent office spaces to house their employees, resulting in costs related to rent and utilities.
• Software and hardware costs : Technology companies must continually update their hardware and software infrastructure, contributing to operating expenses.
• Marketing and advertising : Service and tech companies may spend a significant amount on marketing to reach target customers and promote their offerings.

The provided table gives a comparative overview of the main operating expenses in the Retail and Manufacturing, and Services and Technology industries:

In conclusion, operating expenses vary between industries, with Retail and Manufacturing focusing more on physical goods, inventory management, and store maintenance, while Services and Technology concentrate on innovation, attracting skilled employees, and investing in digital infrastructure.

Trends and Future of Operating Expenses

Automation and technology.

As businesses across various industries continue to evolve, the integration of automation and technology is playing an increasingly significant role in shaping the future of operating expenses. Companies are embracing innovative solutions to streamline processes, reduce costs, and enhance efficiency.

One notable trend in automation is the implementation of robotic process automation (RPA) , which streamlines repetitive tasks, such as data entry and invoice processing. This approach not only minimizes human error but also allows employees to focus on more value-added activities. As technology advances, more sophisticated AI-driven solutions will further optimize business operations, resulting in reduced operating expenses.

Companies are also leveraging technologies like Internet of Things (IoT) and smart devices to enhance efficiency in various aspects of their operations. Examples include:

• Energy management : Utilizing smart thermostats and energy-efficient lighting to reduce utility costs.
• Remote work : Cloud-based platforms and collaboration tools allowing employees to work remotely, thereby reducing office space and related expenses.
• Inventory management : IoT devices and real-time tracking enabling more efficient supply chain and stock management.

Sustainable Practices

Another major trend impacting the future of operating expenses is the growing emphasis on sustainable practices . As businesses become more conscious of their environmental impact, they are adopting cleaner, greener approaches to minimize waste and conserve resources.

Some key sustainable practices businesses implement to reduce operating expenses are:

• Reducing paper usage : As businesses increasingly switch to digital documentation, processes become more efficient, reducing stationery costs and improving overall sustainability.
• Green energy : By utilizing renewable energy sources such as solar or wind power, companies can decrease their dependence on fossil fuels, reducing both energy costs and environmental impact.
• Efficient waste management : Establishing recycling programs and adopting waste reduction measures help reduce disposal costs and contribute to overall sustainability efforts.

These trends in automation, technology, and sustainable practices are shaping a future of growth and efficiency in operating expenses across multiple industries. This evolution is crucial for businesses aiming to stay competitive and adapt to evolving customer expectations and market demands.

Frequently Asked Questions

How are operating expenses reflected in an income statement.

In an income statement, operating expenses are listed below the gross profit, which is calculated by subtracting the cost of goods sold (COGS) from total revenue. The difference between gross profit and operating expenses reflects the operating income. This offers insight into the company’s efficiency in generating profit from its primary business activities.

Which expenses are classified as non-operating versus operating?

Operating expenses are the costs associated with the day-to-day running of a business, such as rent, utilities, and salaries. Non-operating expenses are costs not directly related to primary business operations and can include losses from investments, interest expenses, and income tax expenses. These non-operating expenses are usually listed separately in the income statement.

What items are typically included on an operating expense list?

Typical operating expenses include:

• Rent and utilities
• Office expenses (supplies, internet, phone bills)
• Employee salaries and wages
• Payroll taxes and employee benefits
• Insurance premiums
• Maintenance and repair costs
• Marketing and advertising expenses
• Depreciation and amortization
• Research and development costs

How do you calculate operating expenses based on the common formula?

Operating expenses can be determined by adding all the costs associated with the day-to-day operations of the business. The formula is as follows:

Operating Expenses = Rent Costs + Utility Costs + Employee Salaries + Office Expenses + Marketing Costs + Maintenance & Repairs + Depreciation & Amortization + R&D Costs + Other Operating Costs

Are employee salaries and wages considered operating expenses?

Yes, employee salaries and wages are considered operating expenses. These costs are an essential part of running a business and contribute directly to the company’s day-to-day operations.

What differentiates operating expenses (OPEX) from cost of goods sold (COGS)?

Operating expenses represent the general costs of running a business, while the cost of goods sold (COGS) refers specifically to the direct costs involved in producing goods or delivering services. COGS includes raw materials, labor, and manufacturing overhead. In contrast, OPEX covers expenses like rent, salaries, and utilities, which are not directly tied to production but are necessary for business operations.

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Operating expenses: overview, definition and examples.

One of the responsibilities of management is determining how to reduce operating expenses without affecting the ability to compete with competitors. Understanding operating expenses and how they impact your business are crucial skills. Use this guide to learn how to identify, track, and manage operating expenses to benefit your company’s continued growth and financial health.

Key Takeaways 

• Insurance, license fees, rent, property taxes, and travel expenses are common examples of operating expenses. 
• An increase in operating expenses means less profit for a business. 
• Operating expenses aren’t included in COGS because they are the cost of daily operations and are not related to the production of a product or service.
• Full-time salaries and hourly wages are considered expenses, but the cost of hiring labor to produce products is calculated separately under COGS.

Here’s What We’ll Cover:

What are Operating Expenses?

What is included in operating expenses, what does an increase in operating expenses mean, what are non-operating expenses, operating expense ratio, are wages operating expenses.

Operating Expenses and Capital Expenditures

Importance of Operating Expenses

Frequently Asked Questions

NOTE: FreshBooks Support team members are not certified income tax or accounting professionals and cannot provide advice in these areas outside of supporting questions about FreshBooks. If you need income tax advice, please contact an accountant in your area.

Operating expenses are expenses a business incurs to keep running, such as wages and supplies. They do not include the cost of goods sold (materials, direct labor, manufacturing overhead) or capital expenditures (larger expenses such as buildings or machines).

Think of operating expenses as the cost a business incurs for doing business — they’re part of a business’s core operations. They vary based on the structure of the company. Operating expenses are reflected on a company’s income statement.

Operating expenses include:

• Payroll for staff (excluding labor for manufacturing)
• License fees
• Marketing (including for social channels like Facebook)
• Accounting fees
• Building maintenance and repairs
• Office supplies
• Attorney fees
• Property taxes on real estate
• Vehicle expenses
• Travel expenses

Operating Expenses Examples 

Below are some examples of what could be considered operating expenses:

• Compensation and any related payroll tax expenses for any non-production employees like sales reps, front-of-house staff, receptionists, or administrative staff.
• Benefits provided to non-production employees, including insurance, retirement funds, and PTO expenses.
• Office supplies and administrative expenses required for the company’s daily operations, such as printer paper, pens, computers, telephone lines, or office furniture.

FreshBooks expense tracking software can help businesses efficiently track and categorize their operating expenses, such as rent, utilities, insurance, and travel expenses. This feature helps businesses stay on top of their operating expenses, monitor their cash flow, and identify areas where they can reduce costs. It can also automatically organize categories such as office expenses, travel expenses, and equipment expenses. Our expenses tracking feature helps you save time and reduces the risk of errors. Click here to sign up for your free trial.

An increase in operating expenses and overhead costs means less profit for a business. They receive the most scrutiny from a company, as these costs may be less fixed than their non-operating expenses, manufacturing costs, and capital expenditures.

A company’s senior management tries to reduce operating expenses and utility costs by outsourcing areas of the business or allowing some of the existing staff to work from home. This cuts down on the actual physical space needed for staff at the office. Management also implements money-saving techniques such as automating parts of the business or reducing salaries for new hires.

Non-operating expenses are unrelated to a company’s day-to-day business operations or manufacturing. Non-operating expenses include costs for:

• Depreciation
• Amortization
• Bank fees (including interest charges)
• Lawsuit payments and associated fees
• Currency exchange fees
• Restructuring costs
• Obsolete inventory (products that can no longer be sold)

The operating expense ratio (OER) is the cost of operating a piece of property compared to the income the property brings in. It’s a very popular ratio for real estate, such as with companies that rent out units. A low OER means less money from income is being spent on operating expenses.

OER can also be used to gauge the difference in operating costs between two properties. For instance, if a company owns two similar plants in Michigan with similar outputs, and one’s OER is 15% more than the other, management should investigate why.

Operating Expenses and Capital Expenditures 

Capital expenditures include long-term investments such as purchasing a new building, production machinery, or patents. They are major purchases made by the company and used over a long period of time. Think of capital expenditures as long-term assets that increase the company’s productivity, output, or performance over several years.

Operating expenses typically include supplies, advertising expenses, administration fees, wages, rent, and utility costs. It’s important to pay attention to the distinction between operating expenses and capital expenditures, especially in regards to capital or physical asset-related costs, since the two expenditures are treated differently for accounting purposes.

Importance of Operating Expenses 

Operating expenses are important because they help assess a company’s costs, reduce operating costs, and stock management efficiency. Essentially, they highlight the level of cost a company needs to make to generate revenue, which is ultimately the main goal of any business. When a business doesn’t successfully track its operating expenses, it can end up losing money on spending oversights. Diligent accounting of operating expenses keeps profits on growth for continued success.

Understanding operating expenses is vital for you to keep accurate accounting records and stay focused on keeping your business profitable and strong. More overhead costs and operating expenses mean less profit for your business. By tracking operating expenses accurately and quickly, you can make informed, forward-thinking decisions that help you scale and succeed long-term.

FAQs on Operating Expenses

Is income tax expense an operating expense .

No, income tax expense is considered a non-operating expense and should not be included when calculating operating expenses for a business.

Is Operating Expense a Liability or Asset? 

Operating expenses are represented on a balance sheet as a liability. Because they are a financial expense that does not directly contribute to selling services or products, they aren’t considered assets.

Is Operating Expense Fixed or Variable? 

Operating expenses can be either fixed or variable. Most operating costs are considered variable costs because they change with the production level or size of the business.

How do Operating Costs Affect Profit? 

Operating expenses differ by industry and how a company decides to operate based on its business model. As a general rule, an increase in any type of operating costs lowers profit.

Are Operating Expenses Included in COGS?

No, operating expenses and cost of goods sold are shown separately on a company’s income statement. This is because the cost of goods sold is directly related to the production of a product, as opposed to daily operations.

Administrative expenses such as full-time staff salaries or hourly wages are considered part of a company’s operating expenses. The costs for hiring labor to produce a product are calculated separately under the cost of goods sold.

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How To Write the Operations Plan Section of the Business Plan

Susan Ward wrote about small businesses for The Balance for 18 years. She has run an IT consulting firm and designed and presented courses on how to promote small businesses.

Stage of Development Section

Production process section, the bottom line, frequently asked questions (faqs).

The operations plan is the section of your business plan that gives an overview of your workflow, supply chains, and similar aspects of your business. Any key details of how your business physically produces goods or services will be included in this section.

You need an operations plan to help others understand how you'll deliver on your promise to turn a profit. Keep reading to learn what to include in your operations plan.

Key Takeaways

• The operations plan section should include general operational details that help investors understand the physical details of your vision.
• Details in the operations plan include information about any physical plants, equipment, assets, and more.
• The operations plan can also serve as a checklist for startups; it includes a list of everything that must be done to start turning a profit.

In your business plan , the operations plan section describes the physical necessities of your business's operation, such as your physical location, facilities, and equipment. Depending on what kind of business you'll be operating, it may also include information about inventory requirements, suppliers, and a description of the manufacturing process.

Keeping focused on the bottom line will help you organize this part of the business plan.

Think of the operating plan as an outline of the capital and expense requirements your business will need to operate from day to day.

You need to do two things for the reader of your business plan in the operations section: show what you've done so far to get your business off the ground and demonstrate that you understand the manufacturing or delivery process of producing your product or service.

When you're writing this section of the operations plan, start by explaining what you've done to date to get the business operational, then follow up with an explanation of what still needs to be done. The following should be included:

Production Workflow

A high-level, step-by-step description of how your product or service will be made, identifying the problems that may occur in the production process. Follow this with a subsection titled "Risks," which outlines the potential problems that may interfere with the production process and what you're going to do to negate these risks. If any part of the production process can expose employees to hazards, describe how employees will be trained in dealing with safety issues. If hazardous materials will be used, describe how these will be safely stored, handled, and disposed.

Industry Association Memberships

Show your awareness of your industry's local, regional, or national standards and regulations by telling which industry organizations you are already a member of and which ones you plan to join. This is also an opportunity to outline what steps you've taken to comply with the laws and regulations that apply to your industry. 

Supply Chains

An explanation of who your suppliers are and their prices, terms, and conditions. Describe what alternative arrangements you have made or will make if these suppliers let you down.

Quality Control

An explanation of the quality control measures that you've set up or are going to establish. For example, if you intend to pursue some form of quality control certification such as ISO 9000, describe how you will accomplish this.

While you can think of the stage of the development part of the operations plan as an overview, the production process section lays out the details of your business's day-to-day operations. Remember, your goal for writing this business plan section is to demonstrate your understanding of your product or service's manufacturing or delivery process.

When writing this section, you can use the headings below as subheadings and then provide the details in paragraph format. Leave out any topic that does not apply to your particular business.

Do an outline of your business's day-to-day operations, including your hours of operation and the days the business will be open. If the business is seasonal, be sure to say so.

The Physical Plant

Describe the type, site, and location of premises for your business. If applicable, include drawings of the building, copies of lease agreements, and recent real estate appraisals. You need to show how much the land or buildings required for your business operations are worth and tell why they're important to your proposed business.

The same goes for equipment. Besides describing the equipment necessary and how much of it you need, you also need to include its worth and cost and explain any financing arrangements.

Make a list of your assets , such as land, buildings, inventory, furniture, equipment, and vehicles. Include legal descriptions and the worth of each asset.

Special Requirements

If your business has any special requirements, such as water or power needs, ventilation, drainage, etc., provide the details in your operating plan, as well as what you've done to secure the necessary permissions.

State where you're going to get the materials you need to produce your product or service and explain what terms you've negotiated with suppliers.

Explain how long it takes to produce a unit and when you'll be able to start producing your product or service. Include factors that may affect the time frame of production and describe how you'll deal with potential challenges such as rush orders.

Explain how you'll keep  track of inventory .

Feasibility

Describe any product testing, price testing, or prototype testing that you've done on your product or service.

Give details of product cost estimates.

Once you've worked through this business plan section, you'll not only have a detailed operations plan to show your readers, but you'll also have a convenient list of what needs to be done next to make your business a reality. Writing this document gives you a chance to crystalize your business ideas into a clear checklist that you can reference. As you check items off the list, use it to explain your vision to investors, partners, and others within your organization.

What is an operations plan?

An operations plan is one section of a company's business plan. This section conveys the physical requirements for your business's operations, including supply chains, workflow , and quality control processes.

What is the main difference between the operations plan and the financial plan?

The operations plan and financial plan tackle similar issues, in that they seek to explain how the business will turn a profit. The operations plan approaches this issue from a physical perspective, such as property, routes, and locations. The financial plan explains how revenue and expenses will ultimately lead to the business's success.

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Learn from the business planning experts, resources to help you get ahead, startup & operational costs, table of contents, introduction.

Data from reputable organizations like the U.S. Chamber of Commerce and Kaufman Foundation reveal a sobering truth: a significant number of businesses falter and fail within their first few years. One of the critical reasons behind this high failure rate is an inadequate understanding of startup and operating costs. Businesses often stumble due to undercapitalization, inefficient budgeting, and unrealistic financial planning, directly linked to a lack of comprehensive startup and operational cost analysis.

By offering a detailed exploration of startup and operating costs, we aim to equip you with the knowledge and tools necessary for accurate financial assessment and planning. This step is about fostering a deep understanding of the financial framework your business operates within. 

With this comprehensive guide, you’ll gain the insight needed to make informed decisions, set realistic budgets, and price your products or services appropriately. Ultimately, this understanding can be the difference between a business that merely survives and one that thrives. As we move forward on this detailed roadmap, prepare to arm yourself with knowledge that will crucially impact the longevity and success of your venture.

Pro Tip: 

Review ‘Operations in Detail’: If you haven’t thoroughly examined the ‘Operations in Detail’ step or need a refresher, it’s essential to revisit this step. Understanding the operational aspects of your business is critical before you can accurately assess the financial implications.

Understanding Costs

Challenges in startup finance.

Navigating the financial aspects of starting a business is a complex task, often riddled with challenges that can significantly impact the success and sustainability of the venture. In this step, we address some of the most common financial hurdles entrepreneurs face and provide guidance on how to overcome them.

Key Takeaways: Financial Hurdles

• Undercapitalization: Many startups underestimate the capital required to launch and sustain their business until it becomes profitable. This oversight can lead to a cash flow crisis, with the business running out of money prematurely.
• Inadequate Budgeting: A clear understanding of cost structures and operating expenses is vital. Without it, creating an accurate budget is challenging, often leading to over or underspending in critical areas.
• Pricing Issues: Properly setting prices for products or services is crucial. Misjudging costs can result in uncompetitive pricing or, worse, selling at a loss.
• Poor Financial Planning: Comprehensive knowledge of startup and operating costs is essential for realistic financial projections, crucial for effective decision-making and strategic planning.
• Difficulty in Securing Funding: Detailed financial plans and cost analyses are typically required by investors and lenders. Inability to provide this information can make securing necessary funding challenging or, more likely, impossible.
• Operational Inefficiencies: Without a clear grasp of operating costs, identifying areas for cost reduction or efficiency improvements can be difficult, leading to wasteful practices.
• Risk of Business Failure: Ultimately, a lack of understanding of the full financial picture significantly raises the risk of business failure, particularly in the crucial early stages of operation.

Categories of Startup Costs

Your startup costs is the capital you spend before you open your doors to customers and can be broadly categorized into assets, expenses, and working capital, each with its own set of subcategories. It’s crucial to consider various aspects like lease vs. buy decisions, supply ordering strategies, and staffing choices. The following gives an overview of of startup assets, expenses, and working capital: 

Startup assets for a pre-revenue startup are the tangible and intangible resources acquired to create a foundation for the business’s operations and growth. These assets include physical items like equipment and inventory, as well as intellectual properties and digital assets, which provide long-term value and contribute to the startup’s capability, unlike startup expenses that are consumed or depleted through the initial setup. Subcategories for startup assets often include: 

Tangible Assets

• Real Estate: Land and buildings.
• Equipment: Machinery, computers, office equipment.
• Vehicles: Cars, trucks, or vans used for business purposes.
• Furniture and Fixtures: Desks, chairs, lighting, shelving.
• Inventory: Stock of products for sale.
• Equipment: Computers, tablets, servers, displays, phones, printers.
• Safety and Security Equipment: Surveillance cameras, alarms.

Intangible Assets

• Brand and Intellectual Property: Trademarks, patents, copyrights.
• Software and Technology: Custom software, tech tools, digital assets.
• Goodwill: Value attributed to acquiring a brand, its reputation, and its customer relationships.
• Non-Standard Licenses and Permits: Specific industry-related licenses where the license has a value if the business was sold (e.g., liquor license, cannabis license).

Other Assets

• Refundable Deposits: Security deposits for utilities or rent.

Expenses:  

Startup expenses for a pre-revenue startup are the initial outlays necessary to establish and prepare the business for operation, including legal and administrative setup, securing a location, initial marketing, and workforce preparation. Unlike startup assets, which are tangible and intangible items of value the business owns, these expenses are one-time costs primarily aimed at setting up the business infrastructure and operational framework, without residual value or future liquidity. Examples of common startup expense subcategories include: 

Legal and Administrative Expenses

• Legal Fees: Costs for legal advice, company registration, incorporation, patents, and trademarks.
• Licenses and Permits: Fees for obtaining necessary legal permissions to operate.
• Business Planning: Expenses for developing business strategy, model, and plans.
• Consultancy Fees: Expenses for professional services like business consultants, accountants.

Location and Infrastructure Setup

• Broker Fees: Initial payments and fees for securing a business location.
• Utility Set-Up Fees: Initial fees for setting up essential utilities like electricity, water, and internet.

Insurance and Risk Management

• Insurance Deposits: Initial deposits for various business insurance policies.
• Business Insurance Premiums for First Term: Initial premium payments for business-related insurance policies.

Marketing and Branding

• Branding: Costs for creating brand identity, including logo design.
• Initial Marketing and Public Relations: Costs for establishing initial market presence and public relations efforts.
• Website Development : Expenses for website creation, hosting, and pre-launch maintenance.
• Advertising for Launch: Pre-launch marketing and promotional activities.

Human Resources

• Training Period Salaries and Wages: Compensation for employees during training before business operation begins.
• Pre-Launch Employee Recruitment and Training Costs: Expenses related to hiring and training the initial workforce.

Research and Development

• Market Research: Costs for analyzing market trends, customer preferences, and competition.
• Prototype Development: Costs associated with creating prototypes or initial service models.

Miscellaneous Preparation Costs

• Software and Subscriptions: Pre-operational expenses for business software and service subscriptions.
• Travel and Survey Expenses: Costs associated with market surveys, business location visits, and other pre-operating travel.

Working Capital:  

Working capital for a pre-revenue startup refers to the allocation of cash reserves to cover estimated monthly operating expenses (burn-rate components) and short-term liabilities, along with a buffer for contingencies. This capital is essential to support the startup’s operations through to the point of break-even or until it secures the next round of financing, such as moving from seed to Series A funding, with the amount and duration varying significantly based on the business type and strategy. Common examples of working capital allocations include: 

Cash Reserves

• Initial Funding: Seed capital or initial investment funds obtained through investors, personal savings, loans, or grants.
• Emergency Fund: Additional reserve funds to cover unforeseen expenses or delays in reaching revenue-generating stages.

Monthly Operating Expenses (Burn Rate Components)

• Salaries and Wages: Monthly payroll for employees, including founders and early staff.
• Office Rent and Utilities: Monthly costs for office space, electricity, internet, and other utilities.
• Software and Subscription Services: Regular expenses for essential software, cloud services, and subscriptions necessary for operation.
• Marketing and Advertising: Monthly costs for marketing activities to build brand presence and customer awareness.
• Insurance Premiums: Regular payments for necessary business insurance policies.
• Professional Services: Fees for legal, accounting, and consulting services.
• Research and Development: Ongoing costs for product development, testing, and improvement.

Short-Term Liabilities

• Accounts Payable: Short-term debts or obligations to vendors and service providers.
• Accrued Expenses: Incurred expenses that are recorded but not yet paid.

Buffer for Contingencies

• Contingency Buffer: An additional percentage of the total working capital estimated to cover unexpected costs or delays.

We have developed worksheets for hundreds of common Core Offerings to assist in brainstorming these costs. Download our Startup Cost Worksheet to get started.

Key to Building a Solid Foundation

Feeling overwhelmed.

If you find yourself overwhelmed at this step of estimating startup and operating costs, it might be a sign to revisit earlier steps of the Pre-Planning Process. A thorough and well-executed Business Model Development and Operations in Detail step can significantly ease the burden of this step.

• Revisit Business Model Development: Ensure you have a clear and comprehensive understanding of your business model. This step provides a blueprint that guides your financial planning.
• Review Operations in Detail: A detailed analysis of Key Activities, Key Resources, and Key Partners is crucial. If this step is thoroughly executed, estimating costs becomes a more straightforward research task.

Accurate Cost Analysis

Once you have identified the operational components, research becomes your primary tool. 

Practical Steps in Research:

• For HR costs, utilize platforms like salary.com and Indeed to understand local pay scales and employment benefits.
• Contact vendors and partners for quotes and cost structures.
• Utilize online resources for fixed costs like cloud storage, utilities, and office supplies.

Pre-Planning is a Discipline

• Importance of Granularity: This step demands granularity. Each cost, no matter how small, should be accounted for to build a realistic financial picture.
• Avoiding Premature Adaptations: Remember, this is the Pre-Planning phase. The goal here is not to adapt or make operational decisions based on things you cannot know but to create a solid foundation for your business plan or pitch. Changes and adaptations come later, once you start considering funding methods and adapting to sales, market, or operational realities.

By approaching this step with diligence and attention to detail, you lay the groundwork for a strong and realistic financial plan. This foundation is crucial not only for the initial launch but also for the long-term sustainability and success of your business.

Adjusting for Business Type and Stage

Understanding the distinction between traditional and innovative or new market business ventures is critical when planning startup costs. Each type demands a different approach and perspective on financial planning.

• Traditional Businesses: These are established business models with predictable patterns and well-understood markets. For example, a daycare center needs to consider costs for licensing, facility rental, child care supplies, and staff training. A legal firm has to budget for office space, legal databases, and professional staff. These businesses must think through all elements necessary to become fully operational from the start, aiming for rapid achievement of break-even status.
• Innovative or New Market Ventures: Contrasting with traditional models, these ventures often break new ground or create entirely new markets. For instance, a tech startup developing a unique app may initially focus on costs related to software development, securing intellectual property rights, and market testing. Their startup costs might be leaner if they concentrate on developing a minimum viable product (MVP) and reaching early adopters. The goal is often to demonstrate potential and secure further funding, following milestones like user growth or feature development.

Traditional businesses typically require a comprehensive, all-encompassing financial plan upfront. In contrast, innovative ventures may operate on a more performance-based approach, aligning their financial planning with specific milestones and funding stages like pre-seed or seed rounds.

Recognizing which category your business falls into and planning accordingly can significantly impact the efficiency and effectiveness of your financial strategy.

Tools and Resources for Startup and Operating Cost Attribution

Get your startup and operating cost worksheet.

Efficiently navigate the complexities of startup and operating costs with our comprehensive worksheet, designed to streamline your financial planning process. Available in both MS Excel and Google Sheets formats, this versatile tool offers a structured approach to categorize and calculate various costs.

Analyzing Operating Costs

Day-to-Day Business Expenses

Operating costs form a substantial part of any business’s financial structure. These are the recurring costs necessary for the day-to-day functioning of the business and can be broadly classified into fixed and variable expenses. Additionally, entrepreneurs must account for elements like depreciation, payroll taxes and benefits, and potential interest expenses.

Categorization of Operating Costs

• Fixed Expenses: These are costs that remain constant regardless of business performance, such as rent, salaries (to an extent), and insurance.
• Variable Expenses: Costs that fluctuate based on the level of business activity. Examples include utilities, raw material costs, and commission-based salaries.
• Additional Considerations: Depreciation of assets, payroll-related taxes and benefits, and interest expenses, which may become relevant in cases of debt financing.

Estimation: Implications and Accuracy

• Striving for Granularity: While it’s challenging to perfectly estimate operating costs, aiming for 85% accuracy can significantly reduce financial risks. Many business failures are linked to imprecise cost estimations, leading to the issues highlighted previously. If you aim to get a solid B+ here and have allocated a portion of your working capital for emergency funds and contingencies, you’ll be in a much better position to handle what actually happens in the market. 
• Importance of Detailed Planning: We provide worksheets based on common Core Offerings to assist in thinking through various Cost Structure categories. Access our Operating Cost Worksheets to facilitate thorough planning.

Strategies and Considerations

• Early-stage Cost Considerations: In the initial phases, certain expenses might be higher. For instance, hiring competent employees from the outset often means paying higher salaries. Similarly, ordering smaller quantities of supplies or products can result in higher per-unit costs.
• Industry Averages as Reference Points: While comparing costs with industry averages can be insightful, it’s important to remember that these may not always be applicable, especially for startups or innovative ventures where the cost dynamics can be quite different.

Special Note: Innovative or New Market Ventures:

• Lean Approach to Fixed and Variable Costs: These businesses often plan operating costs with a lean approach, focusing only on the essentials necessary to reach the next phase of development.
• Understanding Burn Rate Schedules: Particularly in pre-seed or seed rounds, understanding and managing the burn rate – the rate at which a company is spending its capital – is crucial. This schedule helps startups plan how long they can operate before needing additional funding, ensuring that they remain solvent while pursuing growth or development milestones.

A thorough and detailed approach to outlining operating costs not only lays a solid foundation for current operations but also prepares the business for future financial strategies and funding phases. This step is about outlining costs with precision and foresight, setting the stage for sustainable growth and successful funding endeavors.

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How Much Does it Cost to Start a Business?

8 min. read

Updated April 25, 2024

What will it cost to start your business? This is a key question for anyone thinking about starting out on their own. You’ll want to spend some time figuring this out so you know how much money you need to raise and whether you can afford to get your business off the ground.

Most importantly, you’ll want to figure out how much cash you’re going to need in the bank to keep your business afloat as you grow your sales during the early days of your business. 

Typical startup costs can vary depending on whether you’re operating a  brick-and-mortar store, online store, or service operation . However, a common theme is that launching a successful business requires preparation.

And while you may not know exactly what those expenses will be, you can and should begin researching and estimating what it will cost to start your business.

• How to determine your startup costs

Like when developing your  business plan , or  forecasting  your initial sales, it’s a mixture of  market research ,  testing , and informed guessing. Looking at your competitors is a good starting point. Once you feel your initial estimates are in the ballpark, you can start to get more specific by making these three simple lists.

1. Startup expenses

These are expenses that happen before you launch and start bringing in any revenue. Here are some examples:

• Permits and Licenses: Every business needs a license to operate, just like a driver needs one to drive. Costs vary depending on industry and location.
• Legal Fees: Getting your business structure set up (sole proprietorship, LLC, etc.) might involve consulting a lawyer and at least will involve the basic business formation fees.
• Insurance: Accidents happen, and insurance protects your business from unforeseen bumps.
• Marketing and Branding: The ways to spread the word about your product or service. They could involve creating a website, creating business cards, or promoting social media.
• Office Supplies : Pens, paperclips, that all-important stapler – the essentials to keep your business humming.
• Rent/Lease: If you need to rent space for your business before you start selling, include those expenses in your list as well.

2. Startup assets

Next, calculate the total you need to spend on assets to get your business off the ground. Assets are larger purchases that have long-term value. They’re typically significant items that you could resell later if you needed or wanted to.

Here are a few examples:

• Equipment:  Think ovens for a bakery, cameras for a photography business, or computers for a tech startup.
• Inventory:  If you’re selling products, you’ll need to stock up before opening your doors (or your online store).
• Furniture and Decorations:  Desks, chairs, that comfy couch in the waiting room – creating a functional and inviting workspace might involve some upfront investment.
• Vehicles: If your business requires a vehicle to deliver your product or service, be sure to account for that purchase here.

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Why separate assets and expenses?

There’s a reason that you should separate costs into assets and expenses. Expenses are deductible against income, so they reduce taxable income. Assets, on the other hand, are not deductible against income.

By initially separating the two, you potentially save yourself money on taxes. Additionally, by accurately accounting for expenses, you can avoid overstating your assets on the balance sheet. While typically having more assets is a better look, having assets that are useless or unfounded only bloats your books and potentially makes them inaccurate. 

Listing these out separately is good practice when  starting a business  and leads into the final piece to consider when determining startup costs. 

3. Operating Expenses

Finally, figure out what it’s going to cost to keep your doors open until sales can cover expenses. Create a list that estimates monthly expenses, such as:

• Payroll (including your own salary)
• Marketing and advertising
• Loan payments
• Insurance premiums
• Office supplies
• Professional services
• Travel costs
• Shipping and distribution

Then, based on your revenue forecasts , calculate how many months it will take before your sales can cover all those monthly expenses. Multiply that number of months by your monthly operating expenses to determine how much you’re going to need to cover operating expenses as your business starts.

This number is often called “ cash runway ” and is a critical number – you need enough cash to fund those early red ink months. This number is how much cash you need to have in your checking account when you open your doors for business.

Calculating how much startup cash you need

To figure out how much money you need to start your business, add the asset purchases, startup expenses, and operating expenses over your cash runway period. This is your total startup costs, and it’s better to overestimate than underestimate these costs.

It often makes sense to invest the time to build a slightly more detailed starting costs calculation. Assuming you start making some sales and those sales grow over time, your revenue will be able to help pay for some of your operating expenses. Ideally, your sales contribute more and more over time until you become profitable.

To do a more detailed calculation, you’ll want to invest the time in a detailed financial forecast where you can experiment with different scenarios. If you do this, you’ll be able to see how much it will cost to start your business with different revenue growth rates. You’ll also be able to experiment with different funding scenarios and what your business would look like with different types of loans.

• Funding Starting Costs

You can cover starting costs on your own, or through a combination of loans and investments.

Many entrepreneurs decide they want to raise more cash than they need so they’ll have money left over for contingencies. While that makes good sense when you can do it, it is difficult to explain that to investors. Outside investors don’t want to give you more money than you need, because it’s their money.

You may see experts who recommend having anywhere from six months to a year’s worth of expenses covered, with your starting cash. That’s nice in concept and would be great for peace of mind, but it’s rarely practical. And it interferes with your estimates and dilutes their value.

Of course, startup financing isn’t technically part of the starting costs estimate. But in the real world, to get started, you need to estimate the starting costs and determine what startup financing will be necessary to cover them. The type of financing you pursue may alter your startup or ongoing costs in a given period, so it’s important to consider this upfront.

Here are common financing options to consider:

• Investment : What you or someone else puts into the company. It ends up as paid-in capital in the  balance sheet . This is the classic concept of business investment, taking ownership in a company, risking money in the hope of gaining money later.
• Accounts payable : Debts that are outstanding or need to be paid after a certain time according to your balance sheet. Generally, this means credit-card debt. This number becomes the starting balance of your balance sheet.
• Current borrowing : Standard debt, borrowing from banks,  Small Business Administration , or other current borrowing.
• Other current liabilities : Additional liabilities that don’t have interest charges. This is where you put loans from founders, family members, or friends. We aren’t recommending interest-free loans for financing, by the way, but when they happen, this is where they go.
• Long-term liabilities : Long-term debt or long-term loans.
• Other considerations for estimating startup costs

Pre-launch versus normal operations

With our definition of starting costs, the launch date is the defining point. Rent and payroll expenses before launch are considered startup expenses. The same expenses after launch are considered operating or ongoing expenses.

Many companies also incur some payroll expenses before launch because they need to hire people to train before launch, develop their website, stock shelves, and so forth.

Further Reading: How to calculate the hourly cost of an employee

The same defining point affects assets as well. For example, amounts in inventory purchased before launch and available at launch are included in starting assets. Inventory purchased after launch will affect  cash flow , and the balance sheet; but isn’t considered part of the starting costs.

So, be sure to accurately define the cutoff for startup costs and operating expenses. Again, by outlining everything within specific categories, this transition should be simple and easy to keep track of.

Your launch month will likely be the start of your business’s fiscal year

The establishment of a standard fiscal year plays a role in your analysis. U.S. tax code allows most businesses to manage taxes based on a fiscal year, which can be any series of 12 months, not necessarily January through December.

It can be convenient to establish the fiscal year as starting the same month that the business launches. In this case, the startup costs and startup funding match the fiscal year—and they happen in the time before the launch and beginning of the first operational fiscal year. The pre-launch transactions are reported as a separate tax year, even if they occur in just a few months, or even one month. So the last month of the pre-launch period is also the last month of the fiscal year.

• Aim for long-term success by estimating startup costs

Make sure you’ve considered every aspect of your business and included related costs. You’ll have a better chance at securing loans, attracting investors, estimating profits, and understanding the cash runway of your business.

The more accurately you layout startup costs and make adjustments as you incur them, the more accurate vision you’ll have for the immediate future of your business. 

Tim Berry is the founder and chairman of Palo Alto Software , a co-founder of Borland International, and a recognized expert in business planning. He has an MBA from Stanford and degrees with honors from the University of Oregon and the University of Notre Dame. Today, Tim dedicates most of his time to blogging, teaching and evangelizing for business planning.

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102 Employees Fired After WPP Scangroup Announced Changes

At least 102 employees were laid off by WPP Scangroup company a marketing service firm in the year ended December. Scangroup said it implemented most of the job cuts in May 2023.

The move is expected to facilitate effective operational excellence and corporate governance, allowing the group to focus on its core business areas.

“In 2023, we continued to progress towards our goal of building a future fit organization by streamlining the workforce and investing in the new talent and skills,” the company’s annual report read.

“We exited 15 percent of the workforce via redundancy in May as a result of the exercise,” the report further read.

However, out of the 102 employees who were laid off, 86 were contract workers while 16 were permanent staff. This adds up to 157 employees it laid off in 2020 when covid-19 pandemic disrupted businesses.

Scangroup Restructuring Plan

Scangroup announced a comprehensive restructuring plan that includes staff layoffs and strategic changes in its corporate structure.

In a statement, the company stated that the restructuring was aiming to facilitate operational excellence.

“The Proposed Restructuring is aimed at optimizing the Company group corporate structure into a leaner, simpler and more efficient structure that will facilitate effective operational excellence and corporate governance, while enabling the Group to focus on core business areas,” the company stated in a statement.

Also Read:  Ruto Reveals Details of Ruiru Company Set to Hire 5,000 Kenyans

The restructuring was also intended to minimize operational and compliance costs while maintaining service delivery in strategic markets.

Scangroup issued a profit warning back in November 2023, citing the “continued subdued economic environment in our markets of operations” as a key factor.

The firm also reported spending Ksh 178 million on a one-time staff retrenchment during that period. The company’s total staff cost a rose of 7.8 percent of Ksh 1.8 billion to 2.01 billion in the year under review.

The company has registered entities in operations in other countries including Ghana, Rwanda, Malawi, Uganda, Gabon, Mozambique, Mauritius and Gambia.

Former CEO Lawsuit

The announcement of the restructuring plan came amid the ongoing legal dispute involving Bharat Thakrar, WPP Plc, and WPP-Scangroup directors.

Also Read:  KUCCPS CEO Explains Why More Than 30,000 Students Chose Degree in Education

Thakrar, who served as Scangroup’s CEO, initiated a Ksh 4.3 billion lawsuit against WPP, alleging “neo-colonialist practices and discriminatory tactics” leading to his removal in 2021.

In a statement, Scangroup is in the process of perusing the court pleadings to enter an appearance and prepare a defence.

“The directors are aware of a case filed by Bharat Thakrar, former CEO, former director, and a current shareholder of the company against the company. Service was effected on 23 April 2024,” the statement stated.

“The company is in the process of perusing the court pleadings to enter an appearance and prepare a suitable defence. The company cannot comment any further as the matter is the subject of an active litigation in court,” the statement further read.

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• How to Start a Business

Business Startup Costs: It’s in the Details

• How to Start a Business: A Comprehensive Guide and Essential Steps
• How to Do Market Research, Types, and Example
• Marketing Strategy: What It Is, How It Works, How To Create One
• Marketing in Business: Strategies and Types Explained
• What Is a Marketing Plan? Types and How to Write One
• Business Development: Definition, Strategies, Steps & Skills
• Business Plan: What It Is, What's Included, and How to Write One
• Small Business Development Center (SBDC): Meaning, Types, Impact
• How to Write a Business Plan for a Loan
• Business Startup Costs: It’s in the Details CURRENT ARTICLE
• Startup Capital Definition, Types, and Risks
• Bootstrapping Definition, Strategies, and Pros/Cons
• Crowdfunding: What It Is, How It Works, and Popular Websites
• Starting a Business with No Money: How to Begin
• A Comprehensive Guide to Establishing Business Credit
• Equity Financing: What It Is, How It Works, Pros and Cons
• Best Startup Business Loans
• Sole Proprietorship: What It Is, Pros & Cons, and Differences From an LLC
• Partnership: Definition, How It Works, Taxation, and Types
• What is an LLC? Limited Liability Company Structure and Benefits Defined
• Corporation: What It Is and How to Form One
• Starting a Small Business: Your Complete How-to Guide
• Starting an Online Business: A Step-by-Step Guide
• How to Start Your Own Bookkeeping Business: Essential Tips
• How to Start a Successful Dropshipping Business: A Comprehensive Guide

There's more to a business than furnishings and office space. Especially in the early stages, startup costs require careful planning and meticulous accounting. Many new businesses neglect this process , relying instead on a flood of customers to keep the operation afloat, usually with abysmal results.

Key Takeaways

• Startup costs are the expenses incurred during the process of creating a new business. 
• Pre-opening startup costs include a business plan, research expenses, borrowing costs, and expenses for technology.
• Post-opening startup costs include advertising, promotion, and employee expenses.
• Different types of business structures—like sole proprietorships, partnerships, and corporations—have different startup costs, so be aware of the different costs associated with your new business.

Startup costs are the expenses incurred during the process of creating a new business. All businesses are different, so they require different types of startup costs. Online businesses have different needs than brick-and-mortars ; coffee shops have different requirements than bookstores. However, a few expenses are common to most business types.

Understanding Common Business Startup Costs

The business plan.

Essential to the startup effort is creating a business plan —a detailed map of the new business. A business plan forces consideration of the different startup costs. Underestimating expenses falsely increases expected net profit, a situation that does not bode well for any small business owner.

Research Expenses

Careful research of the industry and consumer makeup must be conducted before starting a business. Some business owners choose to hire market research firms to aid them in the assessment process.

For business owners who choose to follow this route, the expense of hiring these experts must be included in the business plan.

Borrowing Costs

Starting up any kind of business requires an infusion of capital. There are two ways to acquire capital for a business: equity financing and debt financing. Usually, equity financing entails the issuance of stock, but this does not apply to most small businesses, which are proprietorships.

For small business owners, the most likely source of financing is debt in the form of a small business loan . Business owners can often get loans from banks, savings institutions, and the U.S. Small Business Administration (SBA). Like any other loan, SBA business loans are accompanied by interest payments. These payments must be planned for when starting a business, as the cost of default is very high.

Insurance, License, and Permit Fees

Many businesses are expected to submit to health inspections and authorizations to obtain certain business licenses and permits. Some businesses might require basic licenses while others need industry-specific permits.

Carrying insurance to cover your employees, customers, business assets, and yourself can help protect your personal assets from any liabilities  that may arise. 

Technological Expenses

Technological expenses include the cost of a website, information systems, and software, including accounting and point of sale (POS) software , for a business. Some small business owners choose to outsource these functions to other companies to save on payroll and benefits.

Equipment and Supplies

Every business requires some form of equipment and basic supplies. Before adding equipment expenses to the list of startup costs, a decision has to be made to lease or buy.

The state of your finances will play a major part in this decision. Even if you have enough money to buy equipment, unavoidable expenses may make leasing, with the intention to buy at a later date, a viable option. However, it is important to remember that, regardless of the cash position , a lease may not always be best, depending upon the type of equipment and terms of the lease.

Advertising and Promotion

A new company or startup business is unlikely to succeed without promoting itself. However, promoting a business entails much more than placing ads in a local newspaper.

It also includes marketing —everything a company does to attract clients to the business. Marketing has become such a science that any advantage is beneficial, so external dedicated marketing companies are most often hired.

Employee Expenses

Businesses planning to hire employees must plan for wages, salaries, and benefits, also known as the cost of labor .

Failure to compensate employees adequately can end in low morale, mutiny, and bad publicity, all of which can be disastrous to a company.

Additional Startup Cost Considerations

Have some extra money set aside for any overlooked or unexpected expenses. Most companies fail because they lack the cash to deal with unexpected problems during the business season.

It is important to note that the startup costs for a sole proprietorship differ from the startup costs for a partnership or corporation. Some additional costs a partnership might incur include the legal cost of drafting a partnership agreement and state registration fees.

Other costs that may apply more to a corporation include fees for filing articles of incorporation, bylaws, and terms of original stock certificates.

Launching a new business can be invigorating. However, getting caught up in the excitement and neglecting the details can lead to failure. Above anything else, observe and consult with others who have traveled this road before—you never know where you might learn the business advice that helps your particular business succeed.

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