What counts as operating expenses in accounting and how it shows up on the income statement

Operating expenses are the costs tied to the normal, day-to-day functions of a business, like rent, utilities, and salaries. This overview clarifies what qualifies as operating expenses, how they’re shown on the income statement, and how they differ from non-operating costs—helpful for understanding core business finances.

Multiple Choice

What is included in operating expenses?

Operating expenses are the costs that a company incurs through its normal business operations. This includes a variety of expenses such as rent, utilities, salaries, and cost of goods sold, which are essential for the day-to-day functioning of the business. These expenses are pivotal for producing and delivering goods or services and are vital for generating revenue. The reason this choice is valid is that operating expenses directly relate to the operations that occur regularly and are necessary for running the core business functions. They are recorded on the income statement and are deducted from gross profit to calculate operating profit, indicating the efficiency of the company in managing its operational costs. In contrast, costs related to asset sales typically fall under non-operating activities as they pertain to the sale of long-term assets rather than daily operations. Interest expenses and debt repayments are financial activities rather than operational and do not directly relate to the core functions of the business. Revenue generated from core operations, while important, describes inflow rather than outflow, and thus wouldn't be categorized as an expense. By focusing on the recurring nature of operating expenses, we gain a clearer understanding of what supports the fundamental activities of a business entity.

What counts as operating expenses anyway? If you’ve ever poked around an income statement, you’ve probably noticed a long list of costs that chip away at something called operating income. The broad idea is simple: operating expenses are the costs a company incurs as it runs its day-to-day business. They’re the ongoing bills that keep the lights on, people paid, and products moving from idea to customer. Let’s unpack what that really means, with a few practical examples and a touch of real-world color to keep it from feeling like a dusty ledger.

A practical lens: recurring costs that keep the wheels turning

Think about a business the way you think about a personal budget, but on a larger scale. Some purchases are one-offs—like buying a new printer for the office, a software license you’ll only renew every few years, or a big marketing push that doesn’t recur. Those items don’t typically sit in operating expenses when they’re tied to a specific one-time project; they might land elsewhere on the income statement as asset purchases or one-off charges.

Operating expenses, by contrast, are the recurring costs that show up month after month as part of running the core business. They’re the “every month, we must have this” kind of spending. Here are the usual suspects you’ll see on that line:

  • Rent and lease payments: The space you rent for offices, warehouses, or storefronts. It’s essential infrastructure for daily operations.

  • Utilities: Electricity, water, heating, cooling—everything that keeps the physical space functional.

  • Salaries and wages: The payroll that supports the people who design, manufacture, sell, or service the product.

  • Depreciation and amortization (in many setups): A non-cash expense that spreads the cost of long-lived assets over their useful lives. It’s part of the operating story because it reflects ongoing wear and tear on assets used in daily operations.

  • Cost of goods sold (COGS): This one often sparks questions. COGS includes the direct costs tied to producing goods or delivering services that a company sells. Many organizations classify COGS as an operating expense because it’s tied to the core business activity—creating the product or service that generates revenue. It’s the direct material and direct labor that make the product possible, along with certain factory overhead that supports production.

  • Marketing and sales expenses: Advertising, promotions, commissions, and other costs aimed at making sales happen. These are tied to the core mission of generating revenue, even if the specifics vary by industry.

  • General and administrative (G&A) costs: This bucket covers a lot—HR, finance, legal, admin staff, office supplies, and other overhead necessary to keep the business humming.

Notice what’s not included in operating expenses

If we’re painting the full picture, there are costs that live outside the operating expenses because they’re not part of the routine operations:

  • Interest expenses and debt repayments: Financing costs, like interest on loans, fall under non-operating or financing activities. They’re about how you fund the business rather than how you run it day to day.

  • Asset sales or asset impairment: When you sell a fixed asset or recognize impairment, those are investing or non-operating items rather than operating expenses.

  • Revenue items: Revenue, even if it comes from core operations, is income, not an expense. It sits on the top line and flows through to profitability after expenses are subtracted.

This distinction matters because it helps analysts understand where the money is going and what’s driving day-to-day performance versus what’s tied to financing decisions or exceptional events.

Why operating expenses matter for performance

Operating expenses aren’t just “costs.” They’re a lens on efficiency, discipline, and strategic choices. A company that runs lean on operating expenses can push operating income higher, all else equal. But lean doesn’t mean reckless. The goal is to balance cost control with the need to invest in the product, people, and systems that keep customers happy and growth possible.

A few practical angles you’ll often see in analysis:

  • The operating leverage story: If a company has high fixed operating costs, small changes in revenue can lead to bigger swings in operating income. That can be great when demand is strong, but risky when times get tight.

  • The mix between variable and fixed costs: Some businesses prefer more variable costs so they can scale up or down with demand. Others invest in fixed capabilities that boost speed or quality, trading off flexibility for potential long-run efficiency.

  • The role of COGS: For product-based firms, COGS is a big piece of the puzzle. Managing supplier costs, inventory, and manufacturing efficiency directly affects gross profit and, by extension, operating profitability.

  • The impact of pricing and volumes: If you raise prices or boost sales without a proportional rise in costs, operating income improves. If costs rise faster than revenue, profitability can take a hit.

A tangible way to think about it

Imagine you’re evaluating a small software company that also ships physical gadgets. Its operating expenses might include:

  • Office rent and utilities so the team has a place to collaborate.

  • Software subscriptions that the team uses daily to build and test features.

  • Salaries for developers, product managers, salespeople, and support staff.

  • Customer support costs that keep users satisfied.

  • Depreciation on servers and hardware that host the product and data.

  • COGS for the gadget line, reflecting factory labor, materials, and packaging.

Now picture two scenarios. In the first, revenue grows while operating expenses stay roughly the same. Operating income climbs, signaling healthy scalability. In the second, revenue grows but COGS or other operating costs rise faster, squeezing operating income. Investors care about that balance because it reveals how well the business turns activity into profit.

Why this topic resonates beyond the numbers

For students stepping into the accounting world, the concept of operating expenses isn’t just about memorizing a list. It’s about understanding the rhythm of a business. It’s noticing how a company prioritizes investments—whether it’s more staff, better tooling, or a bigger marketing push—and how those choices show up on the income statement.

Let’s mix a bit of real-world context. Different industries tend to run different operating profiles. A service-based company might devote a larger share to salaries and marketing, while a manufacturing business could see COGS and depreciation as heavy hitters. Retailers juggle rent, utilities, and inventory carrying costs, plus the ever-present challenge of seasonality. The common thread? They’re all seeking that sweet spot where costs are aligned with strategy and revenue potential.

Common pitfalls and quick checks

If you’re ever unsure whether something belongs in operating expenses, ask a couple of quick questions:

  • Is this expense tied to daily operations and the core business activity?

  • Would the cost recur as part of normal business, not tied to a one-off event or financing choice?

  • Does it help produce goods or deliver services that generate revenue?

If the answer to those questions is yes, you’re probably looking at an operating expense. If it’s about a one-off asset purchase, financing, or a non-operating event, it’s likely outside that category.

A nod to the broader financial picture

Operating expenses don’t stand alone. They interact with other elements of financial reporting to tell a story about a company’s health and trajectory. For instance:

  • The gross profit line (revenue minus COGS) sits above operating expenses. It answers how efficiently production is delivering goods or services.

  • Operating income (or EBIT) reveals how well the core business scales after the day-to-day costs are covered.

  • Net income takes into account interest, taxes, and other non-operating items, giving you the bottom-line result.

In practice, savvy analysts compare operating metrics over time and against peers. They look at ratios like operating expense as a percentage of revenue to gauge efficiency, or they track trends in specific categories (like how much is spent on marketing relative to sales). It’s not just about the number itself; it’s about the story those numbers tell.

A gentle digression: the art of budgeting versus forecasting

Here’s a thought to keep in your back pocket: budgeting and forecasting, while related, aren’t the same thing. A budget is a plan—a set of targets for where you want costs to land. Forecasting, on the other hand, is about predicting where you’ll actually end up based on current data. In other words, budgets set the course, forecasts let you adjust the sails. When it comes to operating expenses, this dynamic is especially relevant. Costs aren’t static; they drift with headcount changes, supplier terms, energy prices, and even regulatory shifts.

If you’re studying UNLV’s accounting landscape, you’ll notice the emphasis on understanding how these costs behave in real business contexts. It’s not just about reading a chart; it’s about interpreting what those lines suggest for strategy, risk, and opportunity.

Bringing it home: the practical takeaway

Operating expenses are the lifeblood of day-to-day business administration. They’re the recurring outflows that keep production, service delivery, and customer support humming. They align with the core activities that generate revenue, and they’re a critical piece of the puzzle when you assess profitability and efficiency.

The next time you skim an income statement, try this quick mental checklist:

  • Identify the line items that are ongoing costs of running the business.

  • Separate those from one-time or financing-related items.

  • Consider how each category supports or challenges the company’s ability to generate revenue.

  • Think about the industry context and what a typical cost mix looks like for that sector.

By developing an instinct for what belongs where, you’ll move from simply reading numbers to telling the story behind them. And that, more than anything, is what good accounting is all about—making sense of the business, not just crunching decimals.

If you’re curious to explore further, you might compare a couple of real-world companies in the same field. See how their operating expense profiles differ and ask why those differences exist. Maybe one company prioritizes investments in people and technology, while another leans on streamlined processes and lean overhead. The answers aren’t just about math; they’re about strategy, risk tolerance, and a company’s unique voice in the market.

So yeah, operating expenses aren’t just a line on a chart. They’re a window into how a business chooses to function, how it allocates scarce resources, and how it balances the daily grind with long-term aims. They’re the honest reflection of what it costs to keep the lights on, the machines running, and the customers satisfied. And that’s a story worth reading, page by page.

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