Operating costs are costs that your business has in the course of daily operation. Examples include transportation, raw material and wage costs.
Operating costs can be anything from the cost of raw materials you need to produce goods, commissions that you give to sales staff, or renting premises for your physical store, or the cost you pay for a domain for your online store.
Operating costs can be divided into fixed and variable costs.
Fixed costs versus variable costs
Variable costs are costs that vary depending on your business’ production and sales. These costs fluctuate in proportion to how much work you’re doing.
For example the purchase of raw materials and supplies, packing supplies and delivery costs for your products, and the credit card fees that you incur when customers pay with card.
Fixed costs are costs that are the same no matter how many goods you produce and sell or how many services you deliver. Examples of fixed costs are wage costs, rental costs, insurance and the interest you pay on loans.
Depreciation—the value reduction of expensive, long-term assets in your general ledger—is also a type of fixed cost. It’s time-dependent, not dependent on your production or sales.
Why are operating costs important?
You have to know your operating costs as part of budgeting; It doesn’t matter if you sell a lot of products and services, if you spend more than that on your operating costs. In that case, your business will be running at a loss.
Knowing your operating costs is a step on the way to working out whether your business is profitable, or whether you need to make some changes, like increasing the price of your product, decreasing costs—for example by switching to free invoice software —or increasing your sales with a marketing and sales effort.
You also include information about your operating costs in your income statement—which is one of the financial statements you have to include in your annual report. It’s also a useful report: It shows the financial health of a company. More specifically, it shows whether your company
operated with a profit or loss in the past fiscal year, or another period you choose.