Operating Expense

What is an Operating Expense?

An operating expense is a cost that a business incurs as a result of performing its normal operations. These are the day-to-day costs of running a company: rent, salaries, utilities, office supplies, insurance, and travel and expense programs. Operating expenses appear on the income statement and are fully deductible in the accounting period they occur.

The key distinction is between operating and non-operating costs. Operating expenses relate directly to core business activities. Non-operating expenses, such as interest payments on debt or losses from asset sales, fall outside regular operations. Similarly, capital expenditures (CapEx) fund long-term assets and are depreciated over their useful life rather than expensed immediately.

For finance teams, the operating expense line is where controllable spending lives. Unlike COGS (cost of goods sold), which scales with production volume, operating expenses represent the overhead required to keep the business functioning regardless of output.

Common Types of Operating Expenses

Operating expenses fall into several categories that most companies track separately for budgeting and reporting.

Selling, general, and administrative (SG&A): The broadest category, covering salaries for non-production staff, marketing, rent, office supplies, and professional services. SG&A is typically the largest operating expense line for service-based businesses.

Research and development (R&D): Product development, testing, and innovation costs. Under the 2025 OBBBA legislation, domestic R&D expenditures can again be fully expensed in the year incurred rather than amortized over five years [4].

Travel and expense (T&E): Business travel, meals, lodging, and ground transportation. Global business travel spending reached $1.57 trillion in 2025 [5], making T&E one of the largest controllable operating expense categories for companies with distributed teams. Expense reports and receipt documentation track these costs for compliance and reimbursement.

Facilities and occupancy: Rent, property taxes, building maintenance, and utilities. These are fixed expenses that remain constant regardless of business volume.

Insurance and compliance: General liability, workers' compensation, cybersecurity insurance, and regulatory compliance costs.

Operating Expense vs. Capital Expenditure

The distinction between operating expenses (OpEx) and capital expenditures (CapEx) determines how a cost flows through financial statements and when the business receives the tax benefit.

The Section 179 expensing limit increased to $2.5 million for 2025 under the OBBBA, allowing more capital purchases to receive immediate expense treatment [4]. This blurs the line somewhat, but the fundamental classification remains: operating expenses sustain current operations while capital expenditures build capacity for future periods.

How to Calculate the Operating Expense Ratio

The operating expense ratio (OER) measures what percentage of revenue goes toward operating costs. It's one of the most straightforward efficiency metrics available to finance teams.

Formula: OER = Total Operating Expenses / Total Revenue x 100

A company generating $10 million in revenue with $6.5 million in operating expenses has an OER of 65%. Industry benchmarks provide context for whether that ratio signals efficiency or waste [3]:

A declining OER with steady revenue growth generally signals improving operating efficiency. A rising OER in a mature company may indicate cost creep that warrants investigation. Expense forecasting helps finance teams project whether OER trends will continue or reverse.

Best Practices for Managing Operating Expenses

Categorize by controllability. Distinguish between fixed and variable expenses. Fixed costs like rent and salaried payroll can't be reduced quickly. Variable costs such as travel, contractor fees, and marketing offer near-term flexibility. Focus cost-reduction efforts where changes produce fast results.

Allocate to cost centers. Assigning operating expenses to specific departments or projects creates accountability. When a sales team sees its T&E allocation increasing faster than revenue, the conversation about spending discipline becomes data-driven rather than subjective.

Automate expense capture. Manual expense tracking introduces delays and errors. Navan captures travel and expense data at the point of transaction, eliminating the lag between spending and visibility that makes monthly close unpredictable.

Benchmark quarterly. Compare your OER against industry peers and your own historical trend. A single quarter's ratio means little; a four-quarter directional trend reveals whether operating costs are scaling appropriately with revenue.

Tax Treatment of Operating Expenses

Under IRC §162(a), businesses can deduct operating expenses in the year they're paid or incurred, provided each expense meets two tests: it must be "ordinary" (common and accepted in the trade) and "necessary" (helpful and appropriate for the business) [1]. This immediate deductibility is what separates operating expenses from capital expenditures, which must be depreciated over time.

Starting in 2026, employer-provided meals are generally no longer deductible under the OBBBA, with limited exceptions for industries like food service [4]. Finance teams should review meal and entertainment policies to reflect this change, as T&E meal costs that were previously 50% deductible may now be non-deductible.

The business interest deduction limit now uses EBITDA rather than EBIT for calculating adjusted taxable income [4], which effectively increases the deductible amount for companies with significant depreciation. For companies where operating leases and equipment depreciation are material, this change directly affects the after-tax cost of their operating expense structure.

Consult a tax professional for guidance specific to your organization's jurisdiction and expense mix.

When Should You Consider Alternatives to Standard OpEx Tracking?

Standard spreadsheet-based operating expense tracking works for very small businesses with simple cost structures. Companies should consider more structured approaches when:

• Monthly operating expenses exceed $500,000 and manual categorization creates reconciliation backlogs.
• Multiple departments share cost categories, making allocation across cost centers error-prone.
• Travel is a top-three operating expense but lacks real-time visibility, leaving finance teams to discover overruns weeks after they occur.
• Compliance requirements (SOX, ASU 2024-03 disaggregation) demand expense detail that summary-level tracking can't provide.

Related Terms

• Discretionary Expense: A non-essential operating cost that a business can reduce or eliminate without affecting core operations, such as team events, office perks, or optional training programs.
• Sundry Expenses: Small, irregular operating costs that don't fit neatly into standard expense categories, often aggregated into a single line item for reporting.
• Expense Categories: The classification system that groups operating expenses by type (travel, utilities, marketing) for budgeting, reporting, and tax purposes.

Sources

[1] IRS, "Publication 535: Business Expenses," 2025, https://www.irs.gov/publications/p535

[2] KPMG, "Disaggregation of Income Statement Expenses (DISE)," 2025, https://kpmg.com/us/en/frv/reference-library/2025/disaggregation-income-statement-expenses.html

[3] EconKit, "Operating Expense Ratio Calculator: Industry Benchmarks," reviewed 2026, https://econkit.com/operating-expense-ratio-calculator/

[4] Doeren Mayhew, "OBBBA in 2026: Key Business Tax Planning Considerations," 2026, https://www.doeren.com/viewpoint/obbba-in-2026-key-business-tax-planning-considerations

[5] GBTA, "Global Business Travel Spending to Reach $1.57 Trillion in 2025," July 2025, https://gbta.org/global-business-travel-spending-to-reach-1-57-trillion-in-2025-amid-trade-policy-uncertainty-and-economic-risk-according-to-new-gbta-forecast/