Definition

Operating costs, often referred to as “operational expenses”, are the ongoing expenses that a business incurs in order to maintain its day-to-day operations.

What are operation costs?

Operating costs encompass a wide range of expenditures necessary for the regular functioning of a business. This includes costs associated with production, administration, sales and marketing, research and development, and other activities central to the core operations.

Categories of operating costs:

1. Direct costs (variable costs): These are expenses directly tied to the production or provision of goods or services. They tend to vary with the level of production.
2. Indirect costs (fixed costs): These are expenses that are not directly linked to the production of a specific product or service. They exist regardless of the level of production and are necessary for the general operation of the business. 
3. Semi-variable costs: These costs have elements of both variable and fixed costs.

Operating costs are a crucial component in financial statements and performance metrics. They impact metrics like gross profit margin, operating profit margin, and net profit margin, which provide insights into a company’s profitability and efficiency.

Example of operating costs

A small bakery incurs various operating costs to produce and sell its goods. These costs may include:

1. Rent for the bakery premises.
2. Wages for bakers and other staff.
3. Cost of ingredients such as flour, sugar, and butter.
4. Utility bills for electricity, water, and gas.
5. Packaging materials for products.
6. Maintenance and repair costs for equipment like ovens and mixers.
7. Marketing and advertising expenses.
8. Insurance premiums for liability coverage.

These operating costs are essential for the bakery to run its day-to-day operations and generate revenue from selling baked goods.