Direct Answer
Operating expenses (OpEx) are costs incurred running the core business that are not directly tied to producing goods or services, reported below gross profit on the income statement. They commonly include research and development, selling general and administrative expenses (SG&A), and sometimes depreciation and amortization if it is not already included in cost of goods sold. Operating expenses are subtracted from gross profit to arrive at operating income.
Key Takeaways
- Operating expenses cover the cost of running the core business that isn't directly tied to producing goods or services.
- They are reported below gross profit on the income statement, not mixed into cost of goods sold.
- Common components include research and development and SG&A, and sometimes depreciation and amortization if not already included in COGS.
- Operating income equals gross profit minus operating expenses.
- Whether depreciation and amortization sits in COGS or in operating expenses can vary by company, so comparisons across companies need the same treatment applied consistently.
What Are Operating Expenses?
Operating expenses are the costs a company incurs running its core business that are not directly tied to producing the goods or services it sells. That distinction from cost of goods sold (COGS) is what defines them: COGS captures the direct cost of production, while operating expenses capture what it takes to research, sell, administer, and support that business day to day.
On the income statement, operating expenses are reported below gross profit, not above it. Revenue minus COGS produces gross profit; operating expenses are then subtracted from that gross profit figure to arrive at operating income. Commonly included line items are research and development (R&D) and selling, general and administrative expenses (SG&A), and sometimes depreciation and amortization if those charges are not already embedded in COGS.
Where OpEx Sits on the Income Statement
The income statement moves from revenue down through several layers of profit, and operating expenses occupy a specific spot in that sequence: after gross profit, before operating income.
| Line item | What it represents |
|---|---|
| Revenue | Total sales generated by the business. |
| Cost of goods sold (COGS) | Costs directly tied to producing the goods or services sold. |
| Gross profit | Revenue minus COGS. |
| Operating expenses (OpEx) | Costs of running the core business not directly tied to production - commonly R&D and SG&A, and sometimes depreciation and amortization if not already in COGS. |
| Operating income | Gross profit minus operating expenses. |
Because operating income is calculated as gross profit minus operating expenses, the size of OpEx directly determines how much of gross profit converts into operating income before interest and taxes are applied further down the statement.
Worked Example
Hypothetical example - for education only. Figures below are illustrative and do not represent any real company.
| Line item | Amount |
|---|---|
| Revenue | $500,000 |
| Cost of goods sold | $300,000 |
| Gross profit | $200,000 |
| Research and development | $40,000 |
| SG&A | $90,000 |
| Depreciation and amortization (not in COGS) | $10,000 |
| Total operating expenses | $140,000 |
| Operating income | $60,000 |
Gross profit of $200,000 minus total operating expenses of $140,000 ($40,000 R&D + $90,000 SG&A + $10,000 depreciation and amortization) leaves operating income of $60,000. Every dollar added to or trimmed from operating expenses moves operating income by the same amount, holding gross profit constant.
Why Operating Expenses Matter
Operating expenses show how much a company spends supporting its core business beyond the direct cost of production, and that spending commonly affects how much of gross profit survives to become operating income. A business with high gross margins but heavy R&D or SG&A can still post thin operating income, while a lower-margin business with lean operating expenses may convert more of its gross profit through to the operating line.
How operating expenses trend relative to revenue - rising, falling, or holding steady - can vary a great deal by company, industry, and stage of growth, so there is no single "normal" level to compare against. Reviewing the composition of operating expenses (how much is R&D versus SG&A versus depreciation and amortization) and how that mix changes over time can be more informative than looking at the total figure alone.
Limitations and Common Mistakes
| Mistake | Why it causes problems | Better practice |
|---|---|---|
| Confusing OpEx with COGS | Costs directly tied to production belong in COGS, above gross profit, not in operating expenses below it - mixing the two distorts both gross margin and operating margin. | Check whether a cost is directly tied to producing the goods or services sold before classifying it as an operating expense. |
| Assuming depreciation and amortization is always in the same place | Whether D&A sits inside COGS or inside operating expenses can vary by company, so treating the placement as fixed can misstate comparisons. | Check the income statement footnotes to confirm where a given company reports D&A before comparing operating expense figures across companies. |
| Comparing OpEx dollar figures across very different companies | A larger company will typically report larger absolute OpEx regardless of efficiency, so the raw dollar amount alone says little about how well expenses are managed. | Compare operating expenses as a share of revenue, and only across companies with genuinely similar business models. |
| Treating interest and taxes as part of OpEx | Interest expense and income taxes are reported below operating income, not within operating expenses, so including them overstates OpEx. | Keep operating expenses limited to the costs reported between gross profit and operating income on the income statement. |
Operating expenses are one line item within a broader income statement, and reviewing them in isolation cannot substitute for a fuller review of revenue quality, gross margin trends, balance sheet strength, and cash flow. Classification choices and accounting judgment can also affect exactly what a company includes in its reported operating expenses.
Frequently Asked Questions
What counts as an operating expense?
Operating expenses are costs incurred running the core business that are not directly tied to producing goods or services. They commonly include research and development, selling general and administrative expenses (SG&A), and sometimes depreciation and amortization if those charges are not already included in cost of goods sold.
Is operating expense the same as cost of goods sold?
No. Cost of goods sold (COGS) is subtracted from revenue to arrive at gross profit and represents costs directly tied to producing goods or services. Operating expenses are reported below gross profit and are subtracted from it to arrive at operating income, since they are not directly tied to production.
Does operating expense include interest and taxes?
No. Interest expense and income taxes are reported below operating income, further down the income statement. Operating expenses sit between gross profit and operating income and typically cover research and development, SG&A, and sometimes depreciation and amortization.
Where is depreciation and amortization reported relative to operating expenses?
It can vary. Depreciation and amortization is sometimes included within operating expenses, and it can sometimes already be embedded in cost of goods sold instead, depending on the company and the assets involved. Reviewing the income statement footnotes is the reliable way to confirm which treatment a given company uses.
How is operating expense used to calculate operating income?
Operating income equals gross profit minus operating expenses. Gross profit is revenue minus cost of goods sold, and operating expenses are then subtracted from that gross profit figure to arrive at operating income, before interest and taxes are applied.
Why do operating expenses matter to investors?
Operating expenses show how much a company spends running its core business beyond production costs, which commonly affects how much of gross profit converts into operating income. Trends in operating expenses relative to revenue can vary by company and industry, so context matters more than the dollar figure alone.
How does the split between research, selling, and administrative expenses inform an analysis?
Research spending is an investment in future products, selling spending drives current and near-term revenue, and administrative spending is largely overhead. A company cutting research to protect margin is making a different decision from one cutting administrative costs. The split is disclosed on the income statement for most companies and the composition matters more than the total.
Why do operating expenses sometimes fall while a business grows?
Operating leverage spreads fixed overhead over more revenue, so the ratio to revenue falls while absolute spending rises. Absolute declines usually indicate a cost programme rather than leverage. Distinguishing the two requires looking at absolute spending rather than the ratio, since only one is repeatable.
Where does depreciation and amortisation appear relative to operating expenses?
It is allocated between cost of revenue and operating expense lines based on what the underlying assets support, and most companies do not present it separately on the income statement. The cash flow statement discloses the total. This means operating expenses include a non-cash charge whose size is only visible from the cash flow statement.