Improving your bottom line requires a thorough understanding of your operating expenses. These days, businesses need every possible advantage. Breaking down operational expenses is the first step to analyzing company performance and optimizing costs.
By working with fractional talent to help make sense of your data and build controls for operational expenses, your business can maximize savings without compromising on business quality or talent.
What Are Operating Expenses?
Operating expenses, or OpEx, are the costs a business incurs to generate revenue. They can vary dramatically across different industries and between individual businesses, but a lower OpEx in relation to sales indicates a more efficient management structure. This can directly impact investor confidence as well as your bottom line.
An operating expense is distinguished from other types of expenses by its purpose. Rather than an investing or financing cost, operating expenses serve the main operational and revenue-producing functions of the business.
Administrative fees and depreciation are operating expenses, while cost of goods (COGS) is not. Other OpEx examples include (but are not limited to):
- Utilities
- Rent
- Payroll
- Marketing/Sales
- Legal fees
- Equipment repairs
- Bank charges
- Accounting fees
Identifying operating expenses is vital, because the IRS permits for-profit businesses to fully deduct operating expenses on their taxes.
OpEx vs. CapEx
An operating expense pertains to a company’s everyday commercial activities, and though often recurring, is generally short-term. A capital expense (CapEx) is a long-term investment in tangible assets that’s capitalized on a company’s balance sheet rather than listed as an expense on their balance statement.
For instance, the purchase of manufacturing equipment is a capital expenditure. Ongoing maintenance of that equipment, however, is an operating expense. The difference is important for tax purposes.
Most businesses share a suite of similar operating expenses, like rent and payroll, but each sector also has unique OpEx. In fact, an operating expense in one business might be classified as a capital expense in another. To continue the example above, if a manufacturer bought a building, it would be considered a capital expense. But to a real estate company intended to resell, the purchase of a building would be a COGS expense instead.
Start by Identifying and Categorizing Operating Expenses
Operating expenses are usually categorized as fixed or variable.
- Fixed expenses are those which must be paid in the same recurring amount, irrespective of how much revenue you earn, for example overhead like rent or utilities.
- Variable expenses will change depending on business volume, such as advertising costs, raw materials or shipping fees.
Some costs might fall under either category. A full-time employee is a fixed expense, for instance, while a sales commission is a variable expense. Expenses of this sort are sometimes called semi-variable expenses.
Analyzing Operating Expenses
To analyze your operating expenses, start by calculating your operating expense ratio by dividing OpEx (minus depreciation, if appropriate) by operating income. You can benchmark the resulting operating expense ratio (OER) against industry standards to understand your relative efficiency.
Careful analysis is crucial to improve your OER. Study your data to identify any trends and patterns in your operating expenses and identify areas for potential cost savings. Thorough analysis might reveal an opportunity to negotiate rent or banking charges, for instance, or to reduce utility costs.
The rush of day-to-day business activities coupled with ongoing strategic planning can leave a business without enough time or bandwidth to perform the necessary analysis. A fractional financial professional can help your business find the best solution to extend its cash runway.
Continuously Monitor and Adjust Expenses
Creating a comprehensive budget is fundamental to controlling operating expenses. A well-crafted budget should:
- Reflect your business goals and financial realities
- Include all expected income and expenses
- Allow for some flexibility to handle unexpected costs
Effective operating expense management requires ongoing attention. Regularly reviewing your actual expenses against your budget helps identify areas where you’re overspending or where you might have room to reallocate resources.
Invest in Technology to Automate Processes
While minimizing OpEx is a worthy goal, reducing operating expenses too far can decrease your company’s ability to generate revenue. A fractional expert can position your business to optimize OpEx and establish procedures to continuously monitor and adjust the process.
Investing in technology may seem counterintuitive when trying to reduce OpEx, but the benefits can be significant. Technology solutions can:
- Automate repetitive tasks, reducing labor costs
- Minimize errors, cutting down on costly mistakes
- Provide data analytics for better decision-making
Making Sense of Expense Data
When you have full visibility into the breakdown of your OpEx, you can improve your bottom line by optimizing your spend. This requires a deep dive into data analytics:
- Implement expense tracking systems.
- Develop meaningful KPIs to measure operational efficiency.
- Create data visualizations and reports to provide insights into expense patterns.
- Identify trends and anomalies in spending.
- Use data-driven strategies for cost optimization.
How Fractional Talent Can Help
While these strategies can significantly improve your operating expense management, implementing them effectively often requires specialized expertise. This is where fractional talent can play a crucial role.
Fractional financial experts give businesses access to top-tier professionals on an as-needed basis, providing several advantages:
- Budget Development and Management: A fractional CFO helped a startup create a comprehensive budget that aligned with their growth strategy. By implementing strict budget controls, the company reduced unnecessary spending by 20% in the first quarter.
- Vendor Negotiation: An e-commerce business brought in a fractional finance expert to review their shipping contracts. The expert’s negotiation skills resulted in new agreements that saved the company 15% on shipping costs annually.
- Process Optimization: A manufacturing firm engaged a fractional operations expert to streamline their production processes. The resulting efficiency improvements reduced labor costs by 10% and material waste by 8%.
- Data Analysis and Reporting: A fractional data analyst helped a retail chain make sense of their complex sales and expense data. By creating clear, actionable reports, the company identified underperforming locations and implemented targeted improvements, increasing overall profitability by 12%.
Work With Fractional Talent to Analyze OpEx
Fractional finance experts give businesses access to top-tier financial professionals on an as-needed basis, eliminating the cost of a full-time position, and in turn, minimizing operating expenses.
A fractional expert can analyze your data to identify areas of cost improvement and help your company implement specific strategies depending on the results. They might suggest methods to reduce energy consumption, negotiate favorable contracts with vendors or streamline processes to improve overall efficiency.
Paro can match you with a fractional finance expert 20x faster than traditional recruiters. Work with a skilled finance professional on your terms and maximize your savings.
