Definition of Operating Cost

Operating cost can be defined as the cost of running the administrative and maintenance functions of a business on a daily basis. Operating cost is an element of a business' operating income as reflected in the financial statements of the organization. It can be expressed as the summation of operating expenses and cost of goods sold. A large part of a business's income goes into its operating costs.

What Are the Components of Operating Cost?

Operating costs can fall into three broad categories, including:

  • Fixed cost
  • Variable cost
  • Semi-variable cost

Fixed Cost

A fixed cost is an operating cost which a company must pay and remains constant irrespective of a company's productivity or performance. An example of a fixed cost is the rent paid for the factory space used by a manufacturing company which must be paid, regardless of the company's productivity or profitability. While a company can find a cheaper factory space, it still has to pay for space to house its equipment and manufacturing processes. Therefore, the cost is fixed.

Examples of fixed costs include overhead costs, such as:

  • Office or factory space
  • Equipment
  • Security
  • Insurance

Fixed costs can boost a company's profitability as it increases scalability. If the majority of a company's expenses are fixed, its profit increases with the level of production.

A company whose fixed costs give it economies of scale can spread out the ongoing cost of doing business over the number of unit's produced, effectively reducing the average cost of producing each unit and achieving higher production efficiency.

Variable Cost

Variable costs are expenses that change with the productivity of a company. As the name implies, variable cost increases when production increases and reduce when a company's level of production dips. Variable costs include costs of sourcing for raw materials, electricity bills, water bills, and other utilities.

For example, a food delivery company that sees a surge in demand for its French fries meal requires buying more potatoes to cover the increased demand.

Typically, businesses whose variable costs are higher compared to their fixed costs tend to be more stable as their profitability depends more on sales.

Semi-Variable Cost

The operating costs of a business can also be semi-variable. Semi-variable costs can be considered as costs with elements of fixed and variable costs. While semi-variable costs fluctuate with production levels like variable costs, they are also like fixed costs as a company still needs to pay them when it's not producing.

A common example of semi-variable costs is overtime wages. While the wages a company pays its regular staff is considered fixed cost, any payment for overtime work is considered to be variable cost as it increases and decreases with the company's level of production.

Examples of Operating Costs

The following are examples of the operating expenses of a business:

  • Rents and Facilities: Purchasing, leasing, or renting an office or factory space is an ongoing cost of running a business. Companies that conduct their business from office buildings, strip malls, and local shops have to pay for these expenses.
  • Utilities: Electricity, water, and heat are also operating costs of a business as you pay for these utilities regardless of your company's productivity or profits.
  • Salaries: Your business requires regular and sometimes part-time workers who receive a salary or wage for their contribution to the growth of your company. Salaries are also an ongoing cost of running your business.
  • Equipment Maintenance: With time, the equipment you use to produce your goods and deliver services to customers may develop faults. Expenses for periodic equipment maintenance, warranty coverage, or insurance are also operating costs of your business.
  • Supplies and Equipment: All businesses, regardless of size, require equipment and supplies to carry out product creation and service delivery.
  • Fixtures: These include things such as partitions, signage, paneling, table stands, shelves, lighting, storage cabinets, showcases, and other materials for product display.
  • Leasehold Improvements: Companies also require nonremovable installations, such as electrical wiring and plumbing, carpeting, lighting, security systems, HVAC systems, and others.
  • Legal Compliance: One of the costs of starting a business is registration of the business as a legal entity with the relevant tax and business regulatory agencies of the local council, state, or country where you intend to operate.
  • Marketing and Promotion: Businesses also spend money on marketing and promoting their goods and services on an ongoing basis.

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