To protect the health of your business, you must closely monitor your operating expenses in order to ensure that you are running efficiently enough to be profitable. Your operating expenses are quite simply recurring costs (i.e. bills) you must pay in order for your business to continue operations.
Operating expenses are critical to monitor since they allow you to plan for the future and help you forecast profits more accurately. Specifically for seasonal businesses, it’s important to know your operating expenses because you will still be liable for those costs even when you aren't generating as much revenue. Knowing your average operating costs allows you to set aside money for business downturns.
Here is a simple step-by-step process for calculating your monthly operating expenses:
- Create a budget worksheet.Then pull all your receipts and financial statements from the past 12 months.
- Figure out your fixed expenses. Such expenses don't change on a monthly basis or fluctuate based on production levels or sales volume (e.g. employee salaries, rent or mortgage payments, insurance and payroll taxes, etc.). It's best to go back at least 12 months to confirm that the fixed prices have been stable. Then calculate the total sum of your monthly fixed expenses, or break the total down to monthly expenses to get a more detailed view and to see if your fixed expenses have changed (i.e. rent going up).
- Find an average on your variable expenses. These expenses often fluctuate depending on a number of factors, including how much production took place, the time of year, vendor's price increases or decreases, as well as increases in production and marketing spend. Telephone use, raw materials, hourly wages, commissions and bonuses, inventory, shipping costs and supplies, office supplies, electricity and printing services all fall under the variable expense category. Review at least 12 months' worth of variable expenses, and calculate an average based on a 12-month total (Total Amount ÷ 12 Months = Average). Once again, it might be a good idea to do a month-by-month breakdown, especially if your business is seasonal.
- Add the two together. Take your monthly fixed expense total, and add your variable expense average; the result is your average operational costs. From there, you can go on to calculate your break-even point and your profitability margin.
Examples of What Costs to Include
Items to include will vary from business to business. There’s no singular list that covers every type of business, but here are costs that most have in common:
- Office space rent/lease: This cost should remain consistent for the term of your rental or lease agreement. Remember that leases and rent prices can increase when renewed, so try to budget for it before that time comes.
- Employee wages: When budgeting wages, be sure to make a distinction between hourly and salaried employees. For hourly employees, don’t forget to account for possible overtime payments.
- Employee benefits and pensions: Without any changes in your plan, these payments should remain consistent.
- Routine administrative costs: Recurring administrative costs should be factored into your budget.
- Phone/internet: Your phone and/or internet costs should remain consistent, but remember to periodically check for better plans that offer more for your money.
- Insurance: Insurance premiums should be consistent for the duration of your policy, but increases can happen. As with rent, you should budget for increases before it’s time to renew.
- Taxes: This includes taxes like corporate income, vendor, use or property taxes, which could fluctuate from year-to-year based on how much you grow or how much revenue you take in.
- Debt service: Unless you can adjust your interest rate, your loan payments should remain relatively consistent for the life of the debt.
- Amortization and depreciation: As these costs tend to be prorated or spread across the life of a given asset, they should be suitable for inclusion in your budget.
Costs for maintenance and/or repair might not be fixed, but it’s a good idea to include it in your operating costs. Whether it’s a fax machine, deep fryer or the company car, setting aside money for maintenance and repair ahead of time lets you rebound quicker from unforeseen accidents. Think of supplies similarly: the amount of supplies you use might vary from month to month, but they are still necessary for conducting business.
Considerations for Your Operating Expense Budget
It’s difficult to understand the importance of maintaining a properly sized operating expense budget, but it should be considered the backbone of your business. It monitors the production costs of your products and the salaries of your employees, which in turn build your brand and establish your business’ core competency. Adjustments to its size or composition shouldn’t be made on a whim.
It might feel right to make cuts at certain places to compensate for decreased revenue, but those cuts might also compromise your ability and capacity to reliably conduct business. On the other hand, an incidental windfall shouldn’t be seen as an excuse to expand your business and rack up costs you won’t be able to pay in the future. Remember to maintain your operating costs relative to your capability, and your business will hopefully continue to thrive.