Knowing your business numbers means that you understand the health of your business and have the control to influence it.

Operating costs, which include your cost of goods sold (COGS), is one of the business numbers you definitely want to know and understand.

What is your operating cost?

Your operating cost is the total amount you spend on operating expenses and cost of goods sold (COGS) to run your company. It’s an important number to know since, when compared to your revenue, it shows you how much income you’re bringing in after all of your costs have been covered.

This helps you to stay on top of your profit margin, overhead, and expenses so that you can keep an eye on your business performance and make adjustments when necessary.

COULD YOUR MARGINS BE BETTER? Try our free Profit Margin Calculator to find out.

What counts as an operating cost?

Operating expenses are made up of the ongoing, necessary costs it takes to run your service business. Typical operating expenses include: 

  • Sales and marketing expenses
  • Accounting software
  • Legal fees
  • Utilities
  • Office supplies
  • Insurance
  • Rent or lease payments
  • Raw materials
  • Business travel
  • Repair and maintenance costs
  • Employee salaries and wages

Note: Interest payments on company debt are not considered an operating expense.

Operating costs also include COGS, which consists of the direct material and labor costs it takes to produce a good. For example, COGS can include the wholesale cost of materials or parts that you resell to clients, like fertilizer or a furnace. 

READ MORE: Learn more about COGS and 9 other business metrics to track

Typically, operating expenses are divided into three categories: fixed, variable, and semi-variable. 

Fixed expenses are expenses that don’t change or fluctuate over time, like rent or insurance. 

Variable expenses are fluctuating costs that are influenced by outside factors, like utilities and payroll. 

Semi-variable expenses are costs that can remain relatively stable or occasionally fluctuate, like fuel and overtime pay. 

How to calculate your operating cost

To calculate your operating cost, you’ll need to know both your total operating expenses as well as COGS. You can add up your costs for any timeframe you choose, such as monthly, quarterly, or annually.  

Once you have your total operating costs and COGS for a specific timeframe, add them up to get your operating cost. 

Here’s the operating cost formula: 

Operating cost = operating expenses + COGS

Operating expenses vs. overhead costs

Although operating expenses and overhead costs are often lumped together when calculating your operating cost, they can be separated into two different types of expenses. 

Operating expenses are directly related to your work in the field. They’re the costs it takes to perform a service or to complete a job, like labor and materials. Your operating expenses don’t typically change — since they’re made up of employee or contractor wages and material costs, there’s not a lot of room to make adjustments. 

Overhead costs are general business costs that don’t directly affect a job. Overhead is made up of the costs it takes to run your business, like office rent and utilities. In a service business, your overhead is where you’re most likely to identify opportunities to lower your overall expenses.

Knowing the difference between your operating expenses and overhead can help you to figure out where you can cut costs in order to reach your break-even point or increase your profit margin.

How to reduce operating costs

Operating costs are necessary to keep your service business running smoothly, but that doesn’t mean that you can’t optimize them to ensure that you’re not spending more than you have to each month. Here are some simple ways to reduce your operating costs: 

  • Cut unnecessary costs, like subscriptions you don’t use
  • Renegotiate bills, such as rent, phones, or internet
  • Hire contractors instead of employees for seasonal or part-time roles
  • Downsize your office space
  • Use software to handle administrative tasks like booking clients and scheduling jobs

You should review your operating costs on a regular basis to ensure that you’re hitting your goals and maintaining steady and healthy growth. 

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