What Are Operating Costs? Types, Formula, and Examples

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Operating costs are the expenses a business incurs to run its core operations day to day: making or buying what it sells, paying the people who produce and sell it, and keeping offices, systems and facilities working. On an income statement, operating costs combine the cost of goods sold (COGS) with operating expenses. They exclude non-operating items such as interest on debt, currency translation losses and investment gains or losses. Revenue minus operating costs gives operating income, the profit a company earns from its business before financing and taxes.

What Operating Costs Include

Operating costs include everything needed to generate revenue from the company’s main activity. They leave out costs tied to how the business is financed and to activities outside its core operations.

Cost of goods sold

COGS, sometimes labeled cost of sales or cost of revenue, captures the direct cost of producing goods or delivering services. Typical items:

• Raw materials and components
• Wages and benefits for production workers
• Rent, mortgage payments or property tax on a production facility
• Repairs and maintenance of production equipment
• Utilities for the production facility

Operating expenses

Operating expenses are the ongoing costs of running the business that are not tied to producing a specific good or service. Examples:

• Salaries and benefits of executives, administrators and sales staff
• Legal, banking and accounting fees
• Marketing and advertising
• Travel and entertainment
• Rent and utilities for offices or other non-production sites
• Office supplies and software subscriptions
• Research and development that is expensed rather than capitalized
• Depreciation and amortization of operating assets (sometimes allocated partly to COGS)

What is left out

Non-operating costs sit below operating income on the income statement: interest expense, losses on investments, foreign exchange translation effects and one-off items unrelated to the core business. Capital expenditures (buying a building, a machine or a delivery fleet) are generally not operating costs when paid. They are recorded as assets and then flow into operating costs gradually through depreciation over the asset’s useful life. Income taxes are also excluded. This is why operating costs and total expenses differ: total expenses add interest and taxes on top of operating costs.

The Operating Cost Formula

The calculation uses two lines from the income statement:

Operating cost = Cost of goods sold + Operating expenses

Both figures cover a stated reporting period, so the result describes that period only. A quarterly income statement gives quarterly operating costs. Comparing statements covering different period lengths without adjusting them produces misleading results.

Two related measures put the number in context:

• Operating income = Revenue − Operating costs
• Operating cost ratio = Operating costs ÷ Revenue × 100

The ratio shows how many cents of each revenue dollar go to running the business. Subtract it from 100% and you get the operating margin.

Hypothetical worked example

A hypothetical small bakery reports these annual figures:

Operating costs = $200,000 + $180,000 = $380,000

Operating income = $500,000 − $380,000 = $120,000

Operating cost ratio = $380,000 ÷ $500,000 = 76%, so the operating margin is 24%.

The $15,000 of loan interest does not enter the calculation. It reduces pre-tax profit to $105,000, but it reflects how the bakery is financed, not how efficiently it bakes and sells bread. The ovens’ purchase price is also absent. Only the $20,000 of depreciation for the year counts.

A public company example

Apple’s Form 10-K for the fiscal year ended September 28, 2024 reported cost of sales of $210.4 billion and operating expenses of $57.5 billion. Using the formula, operating costs were $267.9 billion for that year. Investors who pull the same two lines from several years of filings can see whether costs grew faster or slower than revenue.

Fixed, Variable and Semi-Variable Costs

The COGS and operating expense split shows where a cost sits on the income statement. A second classification shows how a cost behaves when output or sales change.

Fixed costs

Fixed costs stay the same within a normal range of activity and continue even if production falls to zero. Factory rent, insurance premiums, base salaries and equipment leases are common examples.

Fixed costs create economies of scale. Suppose (hypothetically) a workshop pays $5,000 a month in rent. At 1,000 units a month, rent adds $5.00 to each unit. At 2,000 units, it adds $2.50. The total cost is unchanged, but the per-unit cost halves, which is one reason large producers can price below smaller rivals.

The effect has limits. A single facility can only produce so much. Growing beyond that point means a second facility, and fixed costs step up again.

Variable costs

Variable costs rise and fall with production and drop to zero when production stops. Raw materials, packaging, piece-rate labor, shipping per order and the electricity that runs production machines are typical.

Variable costs do not always rise in a straight line. Volume discounts can lower the unit price. A hypothetical supplier might charge $3.00 per yard of fabric for 500 yards but $1.50 per yard for 1,000 yards. Total spending still goes up as output rises; it just goes up more slowly per unit.

Semi-variable costs

Semi-variable (or semi-fixed) costs have a fixed base plus a portion that moves with activity. They persist at zero output but grow as output rises. Labor is a common case: a core workforce is paid regardless of volume, while overtime pay rises and falls with production. A utility bill with a fixed monthly service charge and a usage charge follows the same pattern.

Separating these components matters for forecasting. If a business expects sales to rise 20%, only the variable portions of its operating costs should rise in step. The fixed base stays put until capacity runs out.

How Operating Costs Are Used

Measuring operating profitability. Operating income isolates how well the core business converts revenue into profit, independent of debt levels and tax situation. That makes it easier to compare companies with different capital structures, and it feeds measures such as EBIT-based enterprise value multiples.

Tracking efficiency over time. A falling operating cost ratio means revenue is growing faster than the cost of producing it, or costs are being cut. A rising ratio points to cost pressure, pricing weakness or heavy investment that is expensed.

Analyzing stocks. For stock analysis, useful operating expense lines to examine include SG&A as a share of revenue, R&D spending, depreciation and amortization, and stock-based compensation, which many companies include in operating expenses. Comparing each line’s growth rate with revenue growth shows where margins are expanding or shrinking.

Budgeting and estimating future costs. Businesses project variable costs from expected volume, hold fixed costs at contracted levels, and adjust for price changes such as wage increases and general inflation. Historical U.S. inflation rates by year offer one reference point, though a company’s own input costs can move very differently from the consumer price index.

Valuation. Projected operating costs determine projected operating profit and free cash flow, which are the core inputs of a discounted cash flow model.

Operating Costs vs. Related Terms

SG&A

Selling, general and administrative expenses cover the costs of managing the company, marketing and selling its products, and getting them to customers. SG&A excludes the direct cost of making the product, which sits in COGS. SG&A is therefore part of operating expenses, which are in turn part of operating costs. Some companies also report R&D or depreciation as separate operating expense lines outside SG&A.

Operating expenses (OpEx)

People often use “operating expenses” and “operating costs” interchangeably, but under the formula above, operating expenses exclude COGS while operating costs include it. When reading a filing or a report, check which definition the author is using.

Capital costs

Capital expenditures buy long-lived assets and are recorded on the balance sheet, while operating costs are consumed within the period. A company deciding whether to lease equipment (an operating payment) or buy it (a capital outlay recovered through depreciation) is choosing between the two. Large capital projects are usually evaluated with net present value, with expected operating costs as one of the cash outflows.

Direct vs. indirect costs

Direct costs (mostly COGS) can be traced to a specific product. Indirect costs, or overhead, support the business as a whole and are mostly recorded within operating expenses such as SG&A.

Limitations

Classification varies. Companies decide where certain items go. One manufacturer may put freight or depreciation in COGS while a peer places them in operating expenses. Total operating costs remain comparable, but subtotals such as gross margin may not be.

Capitalization changes the timing. Costs that are capitalized, such as qualifying software development, do not appear as operating costs when incurred. Instead they are amortized over later periods. Two companies with identical spending can therefore report different operating costs in the same year.

Cost cutting has a lag. Reducing operating costs is often faster than growing revenue, which makes it tempting. But if a company cuts three of its four customer service staff, payroll savings arrive immediately while slower service and lost customers show up later as weaker revenue.

No universal benchmark. No single operating cost percentage fits every profitable business. A software firm, a grocer and an airline have very different cost structures, and labor’s share of operating costs also varies by industry. Meaningful comparisons are against the company’s own history and close industry peers.

A single period says little. One year’s figure can be distorted by restructuring, unusual expenses or a revenue spike. Looking at several years or quarters, alongside revenue and operating margin, shows whether management is controlling costs or just shifting them between periods.

FAQs

The Bottom Line

Business owners, budget planners and stock investors use operating costs to judge how efficiently a company turns revenue into profit. The most reliable reading comes from tracking the operating cost ratio across several years and comparing it with the company's own history and close industry peers. Separating fixed and variable costs also makes forecasts more realistic when sales volumes change.