What type of expenses are operating costs?

What are operating costs?

Operating costs encompass all expenses involved in the normal functioning of a business. These costs don’t include the cost of producing goods (COGS) or non-operating expenses like interest or taxes. Instead, they represent the general overhead and administrative expenses necessary to sustain daily operations and generate revenue.

How to categorize operating costs

• Record under Operating Expenses in your income statement.
• Separate into two main categories:
  • Fixed operating costs: Expenses that stay consistent regardless of output (e.g., rent, insurance).
  • Variable operating costs: Expenses that fluctuate with activity (e.g., utilities, shipping, commissions).
• Use clear chart of accounts categories like Rent, Salaries, Utilities, Insurance, and Marketing.
• Exclude financing costs, capital expenditures, and taxes — these are non-operating expenses.
• Regularly analyze operating costs to assess efficiency and profit margins.

Examples of operating costs

• Rent or lease payments.
• Utilities (electricity, water, internet).
• Employee wages and benefits.
• Office supplies and maintenance.
• Insurance premiums.
• Marketing and advertising.
• Professional services (legal, accounting, consulting).
• Software subscriptions and IT services.
• Depreciation of office equipment or furniture.

Tax implications for operating costs

• Operating costs are fully tax-deductible as ordinary and necessary business expenses.
• They’re deducted in the year they’re incurred under the accrual method (or when paid under the cash method).
• Capital expenses, such as purchasing buildings or equipment, must be capitalized and depreciated, not included as operating costs.
• Accurate classification helps determine taxable income and net profit.
• Keep detailed records and receipts for all operating expenses to substantiate deductions.