Contents
- What is Opex?
- How to manage opex effectively
- Types of opex
- How to calculate opex
- What are the examples of opex?
- Depreciation and amortisation
What is opex?
Opex, also known as an operating expense, is a regular and necessary cost a business incurs to maintain its day to day operations. Opex are crucial for the basic functioning of a business and are typically recurring. They cover the essential needs that keep the business operational but are not directly linked to the production or sale of goods.
Therefore, unlike variable costs that fluctuate with sales volume, opex tend to remain consistent regardless of the business’s revenue levels.
Opex are deducted from an entity’s total revenue to determine its operating income or profit. Consequently, if these expenses are high, it can result in reduced profits. This decrease in profitability can affect important financial ratios and the general financial well being of the business.
According to AASB 101, opex are the costs a business incurs through its regular activities that are essential for generating revenue. These expenses vary depending on the nature of the business and can differ significantly across different industries.
This variation is crucial, especially when considering tax deductions, as what qualifies as an operating expense in one industry might not in another.
Typical opex include a range of costs such as renting property, accounting services, bank charges, marketing expenses, office supplies, employee salaries (payroll), and utility bills.
It’s important to note that the Cost of Goods Sold (COGS), which is directly related to the production of goods or services, is also considered an operating expense.
How to manage opex effectively
One of the primary responsibilities for any organisation’s management is to effectively reduce operational costs while ensuring the entity remains competitive in the market.
Opex are unavoidable, but savvy organisations employ proven strategies to minimise them and enhance profitability.
Here are some actionable steps to consider:
Data Driven Financial Choices: Utilise data analysis to make informed spending decisions. By scrutinising financial data, you can identify patterns, trends, and anomalies, enabling you to make timely and well informed choices to rectify any financial issues.
Adaptability in Budgeting: While budget planning is crucial, it’s equally important to maintain the flexibility to adapt when necessary. Economic fluctuations, industry conditions, and unforeseen events can impact your expenses. The ability to adjust your budget in response to these changes is a valuable asset.
Employee Engagement: Motivated and engaged employees tend to perform better. Encourage your team to actively participate in cost saving discussions. By involving them in financial decisions, you make them feel invested in the entity’s financial stability.
Striving for Ongoing Operational Excellence: Foster a culture of continuous improvement within your organisation. Encourage team members to contribute ideas for cost reduction and efficiency enhancement. Regularly assess your processes and identify areas where improvements can be made.
Industry Benchmarking: Benchmark your spending against peers in your industry. This comparative analysis can provide valuable insights into optimising your financial operations. Learning from industry leaders can help you identify best practises and opportunities for improvement in your own operations.
Types of opex
According to AASB 101, operational expenses can be divided into two primary categories: fixed and variable costs.
Fixed costs
These are costs that remain relatively constant regardless of fluctuations in production or sales volumes. Common examples of fixed costs include items such as rent, insurance premiums, annual salaries, and depreciation costs.
Fixed costs provide a level of predictability and stability in financial planning and budgeting, as they do not vary significantly over time.
Variable costs
In contrast, variable costs are directly linked to changes in production or sales volumes. Examples of variable costs include raw materials, direct labour costs, commissions, and shipping expenses.
Variable costs have a direct impact on an entity’s profitability, as they fluctuate in line with the cost of manufacturing goods or delivering services and can be a key factor in financial performance.
How to calculate opex
To calculate opex, you can use a straightforward formula that adds up various cost components. The formula for calculating opex is as follows:
Opex = Payroll or Wages + Sales Commissions + Marketing or Advertising Costs + Rent + Utilities + Insurance + Taxes
What are the examples of opex?
Following are the various types of opex to provide you with a clearer understanding of each of the expenses and how to manage them effectively.
Personnel costs
Personnel expenses encompass all costs related to your workforce. Depending on the size of your team, these expenses can represent a significant portion of your operational costs. They include:
- Employee Salaries: Regular payments to employees for their work.
- Employer Benefit Contributions: Contributions to employee benefits like health insurance and dental plans, in addition to salaries.
- Commissions and Bonuses: Incentives such as sales commissions and performance based bonuses.
- Retirement Plan Contributions: Entity contributions to employees’ retirement plans.
- Payroll Processing Costs and Payroll Taxes: Expenses associated with administering salaries, including payroll software and services, as well as compliance with payroll taxes.
Occupancy expenses
Occupancy costs pertain to the expenses incurred in occupying and maintaining physical business spaces, often ranking among the largest operational expenditures. If your business operates from an office or warehouse, you must account for expenses such as rent, utility bills, property taxes, and building maintenance.
Strategies to reduce occupancy costs include downsizing, efficient space utilisation, remote work arrangements, and shared office spaces.
Administrative expenses
These expenses cover various behind the scenes administrative tasks essential for the smooth operation of a business. This category includes expenses like domain registrations (.io or .org), software subscriptions, legal fees, communication expenses, and office supplies.
To reduce administrative expenses, businesses can adopt efficient procurement practises and leverage technology, such as digital expense tracking tools, to cut stationery costs. Additionally, smart shopping for products and services can lead to cost savings.
Marketing and advertising costs
These expenses encompass the costs associated with creating advertisements, running marketing campaigns, and conducting market research. While marketing may appear costly, it is crucial for business growth. To optimise spending in this area, businesses can strike a balance between various advertising channels and media to maximise return on investment.
For example, digital marketing and email campaigns often provide a cost effective way to reach target audiences compared to high impact traditional methods like billboards and TV ads.
Research and development (R&D) expenses
According AASB 138, research and develop expenditure are recognised as expenses during the period.
R&D expenses are vital, particularly for technology focused businesses. They cover investments in developing fresh concepts, exploring new products, and improving existing ones. Consistent engagement in R&D activities signals a commitment to producing high quality and innovative products, which can benefit both customers and investors.
Careful evaluation is essential to make the most of R&D spending by investing in ideas with promising potential.
Interest and finance charges
Businesses that borrow money incur interest and finance charges as part of their overall opex. To manage these costs, businesses can negotiate favourable borrowing terms, such as lower interest rates and flexible repayment options.
Efficient debt management, including monitoring the amount of debt and creating repayment plans, is crucial. Inventory financing, using inventory as collateral for loans, can also provide working capital for operational expenses and growth opportunities.
Depreciation and amortisation
According to AASB 116, depreciation and amortisation are terms that describe the reduction in the value of assets over time. Despite not involving actual cash outflows, they are considered as expenses on financial statements.
To illustrate, when a business acquires assets such as equipment or buildings, their value decreases as they age or newer alternatives become available. Depreciation is applied to physical assets like machinery or vehicles, while amortisation is used for intangible assets such as patents or copyrights.
These non cash expenses hold significance as they contribute to accurate reporting of a business’s financial health. Additionally, they play a role in determining the amount of taxes a business is required to pay. By incorporating depreciation and amortisation in financial records, businesses can present a more realistic portrayal of their financial status and ensure compliance with tax regulations.
Operating expense ratio
The Operating Expense Ratio (OER) is a financial metric that reveals the proportion of an entity’s revenue utilised to cover opex. Generally, a lower ratio is preferred, as it indicates that the entity is operating more efficiently, with a higher portion of revenue available for profits and growth.
Nonetheless, an excessively low OER might also imply that an entity is not allocating sufficient resources to its operations. This could potentially lead to challenges related to quality control, customer service, or employee satisfaction and retention.
Thus, entities need to strike a balance between maintaining minimal opex and investing in the enhancement of their operations.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.