What it is:
An operating expense is a day-to-day expense incurred in the normal course of business. These expenses appear on the income statement.
How it works (Example):
Operating expense typically excludes interest expense, nonrecurring items (such as accounting adjustments, legal judgments, or one-time transactions), and other income statement items not directly related to a company's core business operations.
Why it Matters:
Operating expense is a key component in the calculation for operating income, and operating income is a crucial component of many financial measures. The lower a company's operating expenses are, the more profitable it generally is.
Several things can affect operating expenses such as pricing strategy, prices for raw materials, or labor costs, but because these items directly relate to the day-to-day decisions managers make, financial measures based on operating expenses are also measures of managerial flexibility and competency, particularly during rough economic times.
It is also important to note that some industries have higher operating expenses than others. This is why comparing operating expenses or income is generally most meaningful among companies within the same industry, and the definition of "high" or "low" expenses should be made within this context.