How to Find Operating Expenses on an Income Statement: A Deep Dive

Locating operating expenses on an income statement is usually straightforward. They are typically found in a section clearly labeled as “Operating Expenses” or “Selling, General, and Administrative Expenses (SG&A)” below the gross profit (or gross margin) and before interest and taxes. This section details the costs a company incurs from its normal business operations, excluding financing and tax-related items.

Understanding the Income Statement Landscape

Before we zero in on operating expenses, let’s quickly revisit the fundamental structure of an income statement, also known as a profit and loss (P&L) statement. Think of it as a financial story, narrating a company’s financial performance over a specific period, like a quarter or a year.

The income statement follows a general formula:

Revenue – Cost of Goods Sold (COGS) = Gross Profit Gross Profit – Operating Expenses = Operating Income (EBIT) Operating Income – Interest and Taxes = Net Income

The sweet spot for finding operating expenses is, therefore, between the gross profit and the operating income lines.

Decoding the Operating Expenses Section

The “Operating Expenses” section isn’t just one monolithic number. It’s usually broken down into more detailed categories, giving you a clearer picture of where the company’s money is going. Common categories include:

• Selling Expenses: These are costs directly related to selling and marketing products or services. Think advertising, sales commissions, delivery expenses, and marketing salaries.
• General and Administrative (G&A) Expenses: These cover the overhead costs of running the business. Examples include salaries for administrative staff, rent, utilities, insurance, legal fees, accounting fees, and office supplies.
• Research and Development (R&D) Expenses: This category captures the costs associated with developing new products or improving existing ones. It includes salaries for researchers, materials, and depreciation of research equipment.
• Depreciation and Amortization: While technically non-cash expenses, these reflect the decline in value of tangible assets (like equipment) and intangible assets (like patents) over time. They are often included within the operating expenses section.

Where to Look: Real-World Examples

To illustrate, let’s imagine we are analyzing the income statement of “Tech Solutions Inc.” Under the “Operating Expenses” section, you might see a breakdown like this:

• Salaries and Wages: $500,000
• Rent Expense: $50,000
• Advertising Expense: $25,000
• Depreciation Expense: $15,000
• Research and Development: $75,000
• Utilities: $10,000
• Total Operating Expenses: $675,000

This detail helps you understand where Tech Solutions Inc. is allocating its resources. Are they heavily investing in R&D, or are they focusing on sales and marketing? This information is crucial for assessing the company’s strategy and future prospects.

Tools and Resources for Finding Information

• Company’s Annual Report (10-K): Publicly traded companies are required to file annual reports with the Securities and Exchange Commission (SEC). These reports contain detailed financial statements, including the income statement.
• Company’s Quarterly Report (10-Q): Similar to annual reports, quarterly reports provide financial data on a shorter timeframe.
• Financial News Websites and Databases: Websites like Yahoo Finance, Google Finance, and Bloomberg provide access to company financial statements.
• SEC’s EDGAR Database: EDGAR (Electronic Data Gathering, Analysis, and Retrieval system) is the SEC’s online database for company filings.

12 Frequently Asked Questions (FAQs) about Operating Expenses

Here are 12 frequently asked questions that shed light on the nuances of operating expenses and how they are presented on the income statement.

1. What’s the difference between operating expenses and cost of goods sold (COGS)?

COGS represents the direct costs associated with producing goods or services (raw materials, direct labor, etc.). Operating expenses, on the other hand, are the costs of running the business, excluding those direct production costs. Think of COGS as factory-floor costs and operating expenses as head-office costs.

2. Why is it important to analyze operating expenses?

Analyzing operating expenses provides insight into a company’s efficiency and profitability. Are expenses rising faster than revenue? Are they effectively managing their overhead? High or rapidly increasing operating expenses can erode profitability and signal potential problems.

3. What does SG&A stand for?

SG&A stands for “Selling, General, and Administrative Expenses.” It’s a common grouping of operating expenses that encompasses the costs of selling and marketing products (selling expenses) and the general costs of running the business (administrative expenses).

4. Are depreciation and amortization always included in operating expenses?

Generally, yes. Depreciation and amortization represent the allocation of the cost of assets over their useful lives. Because they are associated with operating assets (like equipment or buildings), they are typically categorized as operating expenses.

5. How can I compare operating expenses between different companies?

Comparing operating expenses directly can be misleading, especially for companies of different sizes. A better approach is to calculate operating expense ratios, such as operating expenses as a percentage of revenue. This provides a normalized measure that allows for meaningful comparisons.

6. What are some examples of “unusual” operating expenses?

Unusual operating expenses might include restructuring charges, impairment losses, or one-time legal settlements. These are typically disclosed separately on the income statement to avoid distorting the view of ongoing operating performance.

7. How does R&D expense impact a company’s operating income?

R&D expense reduces operating income. While R&D is an investment in the future, it’s treated as an expense in the period it’s incurred. Companies with significant R&D investments will likely have lower operating income in the short term.

8. What is “EBIT” and how does it relate to operating expenses?

EBIT stands for “Earnings Before Interest and Taxes.” It’s calculated as Revenue – COGS – Operating Expenses. EBIT is essentially the same as operating income and represents the profit generated from a company’s core operations before accounting for financing costs (interest) and taxes.

9. Are stock-based compensation expenses included in operating expenses?

Yes, stock-based compensation, which is the value of stock options or restricted stock granted to employees, is typically included in operating expenses, often within the SG&A category.

10. Can a company manipulate its operating expenses?

Unfortunately, yes. Companies can sometimes manipulate operating expenses through accounting tricks, such as deferring expenses or capitalizing costs that should be expensed. This highlights the importance of scrutinizing financial statements and looking for red flags.

11. How do operating expenses differ for service-based vs. product-based businesses?

While the core concept remains the same, the types of operating expenses can differ. Service-based businesses might have higher labor costs and less COGS, while product-based businesses might have higher warehousing and shipping costs.

12. What’s the relationship between operating expenses and the “operating margin?”

The operating margin (also known as the EBIT margin) is calculated as Operating Income / Revenue. It’s a key profitability metric that shows how much profit a company generates from each dollar of revenue after accounting for operating expenses. A higher operating margin generally indicates greater efficiency and profitability.

By carefully examining the operating expenses section of the income statement and understanding these related concepts, you can gain valuable insights into a company’s financial health and its ability to generate sustainable profits. Always remember to look beyond the raw numbers and consider the broader context of the company’s industry, strategy, and competitive landscape.