Ongoing Costs of a Business Explained

Key Takeaways

• Ongoing costs are the recurring expenses a business must pay to operate, including rent, utilities, salaries, and compliance fees.
• These costs can be categorized as fixed, variable, or semi-variable, each affecting business profitability differently.
• Beyond basic expenses, ongoing costs include insurance, technology, professional services, and financing costs, which are often overlooked.
• Managing ongoing costs effectively is crucial for cash flow stability, long-term sustainability, and profitability.
• Businesses should distinguish between upfront vs. ongoing costs when planning budgets to avoid underestimating financial obligations.

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.

Importance of Ongoing Costs in Business Planning

Ongoing costs are more than just a financial obligation; they directly impact how sustainable and competitive a business can be. Companies that accurately estimate and monitor these recurring expenses are better positioned to manage cash flow, reinvest in growth, and weather downturns. Overestimating revenue while underestimating ongoing costs is one of the most common reasons small businesses fail.

Key considerations include:

• Budget accuracy: Tracking ongoing costs ensures that profit margins are realistic.
• Scalability: Businesses with high fixed costs must achieve higher sales volumes to remain profitable.
• Strategic decisions: Knowing which costs are essential vs. adjustable helps when cutting expenses or scaling operations.

What Are the Components of Operating Cost?

Operating costs can fall into three broad categories, including:

• Fixed cost
• Variable cost
• Semi-variable cost

Ongoing Costs vs. Upfront Costs

It is important to distinguish ongoing costs from one-time or upfront costs. Upfront costs include expenses like equipment purchases, licensing fees, and renovations, while ongoing costs are the recurring charges required to keep operations running. For example, in real estate or mortgages, upfront fees might cover appraisal and closing costs, whereas ongoing costs include property taxes, insurance, and maintenance.

Understanding this distinction helps businesses and entrepreneurs:

• Avoid underestimating long-term financial commitments.
• Plan cash flow to cover both initial investment and recurring obligations.
• Make better financing and pricing decisions.

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.

Common Fixed Ongoing Costs

In addition to rent and insurance, businesses often face other fixed ongoing costs that remain consistent month after month. Examples include:

• Software subscriptions for accounting, customer relationship management, or project management.
• Professional services retainers such as legal or accounting fees.
• Long-term equipment leases or licensing agreements.

Because these expenses do not fluctuate, they provide predictability but can also create financial strain during periods of low revenue.

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.

Hidden Variable Ongoing Costs

While raw materials and utilities are typical variable costs, businesses should also account for less obvious ongoing costs that fluctuate with activity levels. These include:

• Shipping and delivery fees that rise with increased orders.
• Commission-based wages for sales staff.
• Transaction fees from payment processors and merchant services.

Monitoring these variable costs closely can help prevent profit margins from being eroded during peak demand.

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.

Managing Semi-Variable Costs Effectively

Semi-variable costs, such as overtime wages, mobile phone bills, or machine maintenance, can creep upward quickly if not monitored. Strategies to manage them include:

• Setting clear limits on overtime hours.
• Negotiating flexible service contracts with vendors.
• Reviewing periodic maintenance schedules to avoid costly breakdowns.

By actively managing these costs, businesses can strike a balance between flexibility and financial stability.

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.

Additional Examples of Ongoing Costs

Beyond the commonly recognized categories, businesses often face additional ongoing costs such as:

• Employee benefits (health insurance, retirement contributions, paid leave).
• Training and professional development for staff.
• Technology upgrades to stay competitive in software and hardware.
• Interest payments on business loans or lines of credit.
• Taxes and regulatory fees, including industry-specific compliance requirements.

Factoring these into long-term financial planning prevents surprises and supports sustainable growth.

Frequently Asked Questions

1. What are ongoing costs in business?
   Ongoing costs are recurring expenses required to keep a business operating, such as rent, salaries, utilities, insurance, and compliance fees.
2. How do ongoing costs differ from upfront costs?
   Upfront costs are one-time expenses like equipment purchases or licensing fees. Ongoing costs are recurring charges such as rent, utilities, or payroll.
3. Why are ongoing costs important for financial planning?
   They impact profitability, cash flow, and scalability. Mismanaging them can quickly erode margins and threaten business survival.
4. What are common hidden ongoing costs?
   Hidden costs may include software subscriptions, payment processing fees, training expenses, and employee benefits.
5. How can businesses reduce ongoing costs?
   Strategies include renegotiating vendor contracts, automating processes, outsourcing non-core functions, and regularly reviewing expense reports.

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