Definition of Operating expense
Operating expense
Any expense associated with the general, sales, and administrative
functions of a business.
Related Terms:
For investment companies, the management fee and "other expenses,"
including the expenses for maintaining shareholder records, providing shareholders with financial statements,
and providing custodial and accounting services. For 12b-1 funds, selling and marketing costs are included.
The total amount that was spent to run a company this year.
The amount of money the company must spend on overhead, distribution, taxes, underwriting the risk and servicing the policy. It is a factor in calculating premium rates.
The risk that the cash flow of an issuer will be impaired because of adverse economic
conditions, making it difficult for the issuer to meet its operating expenses.
The percentage of the assets that were spent to run a mutual fund (as of the last annual
statement). This includes expenses such as management and advisory fees, overhead costs and 12b-1
(distribution and advertising ) fees. The expense ratio does not include brokerage costs for trading the
portfolio, although these are reported as a percentage of assets to the SEC by the funds in a Statement of
Additional Information (SAI). the SAI is available to shareholders on request. Neither the expense ratio or the
SAI includes the transaction costs of spreads, normally incurred in unlisted securities and foreign stocks.
These two costs can add significantly to the reported expenses of a fund. The expense ratio is often termed an
operating expense Ratio (OER).
An accounting statement that summarizes information about a company in the following format:
Net Sales
– Cost of goods sold
--------------------
Gross profit
– operating expenses
--------------------
Earnings before income tax
– Income tax
--------------------
= Net income or (Net loss)
Formally called a “consolidated earnings statement,” it covers a period of time such as a quarter or a year.
An intermediate measure of profit equal to sales revenue
minus cost-of-goods-sold expense and minus variable operating
expenses—but before fixed operating expenses are deducted. Profit at
this point contributes toward covering fixed operating expenses and
toward interest and income tax expenses. The breakeven point is the
sales volume at which contribution margin just equals total fixed
expenses.
A measure of profit that
equals sales revenue for the period minus cost-of-goods-sold expense
and all operating expenses—but before deducting interest and income
tax expenses. It is a measure of the operating profit of a business before
considering the cost of its debt capital and income tax.
operating expenses that vary in proportion to
changes in total sales revenue (total dollars of sales). Examples are sales
commissions based on sales revenue, credit card discount expenses, and
rents and franchise fees based on sales revenue. These expenses are one
of the key variables in a profit model. Segregating these expenses from
other types of expenses that behave differently is essential for management
decision-making analysis. (These expenses are not disclosed separately
in externally reported income statements.)
The profit per unit sold of a product after deducting product
cost and variable expenses of selling the product from the sales price of
the product. Unit margin equals profit before fixed operating expenses
are considered and before interest and income tax are deducted. Unit
margin is one of the key variables in a profit model for decision-making
analysis.
expenses that vary in close proportion to changes
in total sales volume (total quantities of sales). Examples of these types of
expenses are delivery costs, packaging costs, and other costs that depend
mainly on the number of products sold or the number of customers
served. These expenses are one of the key factors in a profit model for
decision-making analysis. Segregating these expenses from other types
of expenses that behave differently is essential for management decisionmaking
analysis. The cost-of-goods-sold expense depends on sales volume
and is a unit-driven expense. But product cost (i.e., the cost of
goods sold) is such a dominant expense that it is treated separately from
other unit-driven operating expenses.
An overly aggressive accrual of operating expenses and the creation of
liability accounts done in an effort to reduce future-year operating expenses.
An operating expense recorded when the allowance for
doubtful accounts is increased to accommodate an increase in uncollectible accounts receivable.
As the term dividend relates to a corporation's earnings, a dividend is an amount paid per share from a corporation's after tax profits. Depending on the type of share, it may or may not have the right to earn any dividends and corporations may reduce or even suspend dividend payments if they are not doing well. Some dividends are paid in the form of additional shares of the corporation. Dividends paid by Canadian corporations qualify for the dividend tax credit and are taxed at lower rates than other income.
As the term dividend relates to a life insurance policy, it means that if that policy is "participating", the policy owner is entitled to participate in an equitable distribution of the surplus earnings of the insurance company which issued the policy. Surpluses arise primarily from three sources:
1) the difference between anticipated and actual operating expenses,
2) the difference between anticipated and actual claims experience, and
3) interest earned on investments over and above the rate required to maintain policy reserves. Having regard to the source of the surplus, the "dividend" so paid can be considered, in part at least, as a refund of part of the premium paid by the policy owner.
Life insurance policy owners of participating policies usually have four and sometimes five dividend options from which to choose:
1) take the dividend in cash,
2) apply the dividend to reduce current premiums,
3) leave the dividends on deposit with the insurance company to accumulate at interest like a savings plan,
4) use the dividends to purchase paid-up whole life insurance to mature at the same time as the original policy,
5) use the dividends to purchase one year term insurance equal to the guaranteed cash value at the end of the policy year, with any portion of the dividend not required for this purpose being applied under one of the other dividend options.
NOTE: It is suggested here that if you have a participating whole life policy and at the time of purchase received a "dividend projection" of incredible future savings, ask for a current projection. Life insurance company's surpluses are not what they used to be.
Money used to purchase fixed assets for a business, such as land, buildings, or machinery. Also, money invested in a business on the understanding that it will be used to purchase permanent assets rather than to cover day-to-day operating expenses.
Earnings
In general, refers to a company's total sales less cost of sales and operating expenses, including interest and income tax.
Contribution Principle
This is the principle which specifies the factors that must be taken into account when calculating dividends. At Canada Life, the key factors are: interest earnings, mortality, and operating expense.
Expensed
Charged to an expense account, fully reducing reported profit of that year, as is appropriate for
expenditures for items with useful lives under one year.
Net operating losses
Losses that a firm can take advantage of to reduce taxes.
Net operating margin
The ratio of net operating income to net sales.
Operating cash flow
Earnings before depreciation minus taxes. It measures the cash generated from
operations, not counting capital spending or working capital requirements.
Operating cycle
The average time intervening between the acquisition of materials or services and the final
cash realization from those acquisitions.
Operating exposure
Degree to which exchange rate changes, in combination with price changes, will alter a
company's future operating cash flows.
Operating profit margin
The ratio of operating margin to net sales.
Operating lease
Short-term, cancelable lease. A type of lease in which the period of contract is less than the
life of the equipment and the lessor pays all maintenance and servicing costs.
Operating leverage
Fixed operating costs, so-called because they accentuate variations in profits.
Operating risk
The inherent or fundamental risk of a firm, without regard to financial risk. The risk that is
created by operating leverage. Also called business risk.
Short-run operating activities
Events and decisions concerning the short-term finance of a firm, such as
how much inventory to order and whether to offer cash terms or credit terms to customers.
GENERAL-AND-ADMINISTRATIVE EXPENSES
What was spent to run the non-sales and non-manufacturing part of a company, such as office salaries and interest paid on loans.
SELLING EXPENSES
What was spent to run the sales part of a company, such as sales salaries, travel, meals, and lodging for salespeople, and advertising.
VARIABLE EXPENSES
Those that vary with the amount of goods you produce or sell. These may include utility bills, labor, etc.
Expenses
The costs incurred in buying, making or producing goods and services.
Operating profit
The profit made by the business for an accounting period, equal to gross profit less selling, finance, administration etc. expenses, but before deducting interest or taxation.
Accrued expenses payable
expenses that have to be recorded in order for the financial statements to be accurate. Accrued expenses usually do not involve the receipt of an invoice from the company providing the goods or services.
Depreciation expense
An expense account that represents the portion of the cost of an asset that is being charged to expense during the current period.
Expenses
Costs involved in running the company.
Office expense
The amount of expense incurred for the general operation of an office.
Payroll expense
The amount paid to employees for services rendered; synonymous with salary expense and wage expense.
Payroll tax expense
The amount of tax associated with salaries that an employer pays to governments (federal, state, and local).
Prepaid expenses
expenses that have been paid for but have not yet been used up; examples are prepaid insurance and prepaid rent.
Rent expense
The amount of expense paid for the use of property.
Salary expense
The amount paid to employees for services rendered; synonymous with payroll expense and wage expense.
Wage expense
The amount paid to employees for services rendered; synonymous with salary expense and payroll expense.
accrued expenses payable
The account that records the short-term, noninterest-
bearing liabilities of a business that accumulate over time, such
as vacation pay owed to employees. This liability is different than
accounts payable, which is the liability account for bills that have been
received by a business from purchases on credit.
cash flow from operating activities, or cash flow from profit
This equals the cash inflow from sales during the period minus the cash
outflow for expenses during the period. Keep in mind that to measure
net income, generally accepted accounting principles require the use of
accrual-basis accounting. Starting with the amount of accrual-basis net
income, adjustments are made for changes in accounts receivable,
inventories, prepaid expenses, and operating liabilities—and depreciation
expense is added back (as well as any other noncash outlay
expense)—to arrive at cash flow from profit, which is formally labeled
cash flow from operating activities in the externally reported statement
of cash flows.
fixed expenses (costs)
expenses or costs that remain the same in amount,
or fixed, over the short run and do not vary with changes in sales volume
or sales revenue or other measures of business activity. Over the
longer run, however, these costs increase or decrease as the business
grows or declines. Fixed operating costs provide capacity to carry on
operations and make sales. Fixed manufacturing overhead costs provide
production capacity. Fixed expenses are a key pivot point for the analysis
of profit behavior, especially for determining the breakeven point and for
analyzing strategies to improve profit performance.
operating activities
Includes all the sales and expense activities of a business.
But the term is very broad and inclusive; it is used to embrace all
types of activities engaged in by profit-motivated entities toward the
objective of earning profit. A bank, for instance, earns net income not
from sales revenue but from loaning money on which it receives interest
income. Making loans is the main revenue operating activity of banks.
operating cash flow
See cash flow from operating activities.
operating leverage
A relatively small percent increase or decrease in
sales volume that causes a much larger percent increase or decrease in
profit because fixed expenses do not change with small changes in sales
volume. Sales volume changes have a lever effect on profit. This effect
should be called sales volume leverage, but in practice it is called operating
leverage.
operating liabilities
The short-term liabilities generated by the operating
(profit-making) activities of a business. Most businesses have three types
of operating liabilities: accounts payable from inventory purchases and
from incurring expenses, accrued expenses payable for unpaid expenses,
and income tax payable. These short-term liabilities of a business are
non-interest-bearing, although if not paid on time a business may be
assessed a late-payment penalty that is in the nature of an interest
charge.
operating profit
See earnings before interest and income tax (EBIT).
variable expenses
expenses that change with changes in either sales volume
or sales revenue, in contrast to fixed expenses that remain the same
over the short run and do not fluctuate in response to changes in sales
volume or sales revenue. See also revenue-driven expenses and unitdriven
expenses.
Operating Cash Flow
Income available after the payment of taxes, plus the value of the
non-cash expenses
degree of operating leverage
a factor that indicates how a percentage change in sales, from the existing or current
level, will affect company profits; it is calculated as contribution
margin divided by net income; it is equal to (1 - margin of safety percentage)
operating budget
a budget expressed in both units and dollars
operating leverage
the proportionate relationship between
a company’s variable and fixed costs
Expense
The reduction in value of an asset as it is used for current company operations.
Operating income
The net income of a business, less the impact of any financial activity,
such as interest expense or investment income, as well as taxes and extraordinary
items.
Operating lease
The rental of an asset from a lessor, but not under terms that would
qualify it as a capital lease.
Prepaid expense
An expenditure that is paid for in one accounting period, but which
will not be entirely consumed until a future period. Consequently, it is carried on the
balance sheet as an asset until it is consumed.
degree of operating leverage (DOL)
Percentage change in profits given a 1 percent change in sales.
operating leverage
Degree to which costs are fixed.
operating risk (business risk)
Risk in firm’s operating income.
Cash Flow Provided by Operating Activities
With some exceptions, the cash effects of transactions
that enter into the determination of net income, such as cash receipts from sales of goods
and services and cash payments to suppliers and employees for acquisitions of inventory and
expenses.
Current Income Tax Expense
That portion of the total income tax provision that is based on
taxable income.
Deferred Income Tax Expense
That portion of the total income tax provision that is the result
of current-period originations and reversals of temporary differences.
Income Tax Expense
See income tax provision.
Operating Earnings
A term frequently used to describe earnings after the removal of the
effects of nonrecurring or nonoperating items.
Operating Income
A measure of results produced by the core operations of a firm. It is common
for both recurring and nonrecurring items that are associated with operations to be included
in this measure. operating income is typically found in multistep income statements and is a pretax
measure.
Fixed Expenses
Cost of doing business which does not change with the volume of business. Examples might be rent for business premises, insurance payments, heat and light.
Operating Lease
One where the risks and benefits, as well as ownership, stays with the lessor.
Operating Line of Credit
A bank's commitment to make loans to a particular borrower up to a specified maximum for a specified period, usually one year.
Operating Loan
A loan advanced under an operating line of credit.
management expense ratio (MER)
The total expenses expressed as an annualized percentage of daily average net assets. MER does not include brokerage fees and commissions, which are also payable by the Fund.
Earnings before interest and taxes (EBIT)
A financial measure defined as revenues less cost of goods sold
and selling, general, and administrative expenses. In other words, operating and non-operating profit before
the deduction of interest and income taxes.
Indirect method
A method of preparing the operating section of the Statement of Cash Flows that does not use the company’s actual cash inflows and cash outflows, but instead arrives at the net cash flow by taking net income and adjusting it for noncash expenses and the changes from last year in the current assets and current liabilities.
accumulated depreciation
A contra, or offset, account that is coupled
with the property, plant, and equipment asset account in which the original
costs of the long-term operating assets of a business are recorded.
The accumulated depreciation contra account accumulates the amount of
depreciation expense that is recorded period by period. So the balance in
this account is the cumulative amount of depreciation that has been
recorded since the assets were acquired. The balance in the accumulated
depreciation account is deducted from the original cost of the assets
recorded in the property, plant, and equipment asset account. The
remainder, called the book value of the assets, is the amount included on
the asset side of a business.
amortization
This term has two quite different meanings. First, it may
refer to the allocation to expense each period of the total cost of an
intangible asset (such as the cost of a patent purchased from the inventor)
over its useful economic life. In this sense amortization is equivalent
to depreciation, which allocates the cost of a tangible long-term operating
asset (such as a machine) over its useful economic life. Second, amortization
may refer to the gradual paydown of the principal amount of a debt.
Principal refers to the amount borrowed that has to be paid back to the
lender as opposed to interest that has to be paid for use of the principal.
Each period, a business may pay interest and also make a payment on
the principal of the loan, which reduces the principal amount of the loan,
of course. In this situation the loan is amortized, or gradually paid down.
breakeven point
The annual sales volume level at which total contribution
margin equals total annual fixed expenses. The breakeven point is only a
point of reference, not the goal of a business, of course. It is computed by
dividing total fixed expenses by unit margin. The breakeven point is
quite useful in analyzing profit behavior and operating leverage. Also, it
gives manager a good point of reference for setting sales goals and
understanding the consequences of incurring fixed costs for a period.
capitalization of costs
When a cost is recorded originally as an increase
to an asset account, it is said to be capitalized. This means that the outlay
is treated as a capital expenditure, which becomes part of the total
cost basis of the asset. The alternative is to record the cost as an expense
immediately in the period the cost is incurred. Capitalized costs refer
mainly to costs that are recorded in the long-term operating assets of a
business, such as buildings, machines, equipment, tools, and so on.
cash burn rate
A relatively recent term that refers to how fast a business
is using up its available cash, especially when its cash flow from operating
activities is negative instead of positive. This term most often refers
to a business struggling through its start-up or early phases that has not
yet generated enough cash inflow from sales to cover its cash outflow for
expenses (and perhaps never will).
cash flow
An obvious but at the same time elusive term that refers to cash
inflows and outflows during a period. But the specific sources and uses
of cash flows are not clear in this general term. The statement of cash
flows, which is one of the three primary financial statements of a business,
classifies cash flows into three types: those from operating activities
(sales and expenses, or profit-making operations), those from
investing activities, and those from financing activities. Sometimes the
term cash flow is used as shorthand for cash flow from profit (i.e., cash
flow from operating activities).
depreciation
Refers to the generally accepted accounting principle of allocating
the cost of a long-term operating asset over the estimated useful
life of the asset. Each year of use is allocated a part of the original cost of
the asset. Generally speaking, either the accelerated method or the
straight-line method of depreciation is used. (There are other methods,
but they are relatively rare.) Useful life estimates are heavily influenced
by the schedules allowed in the federal income tax law. Depreciation is
not a cash outlay in the period in which the expense is recorded—just
the opposite. The cash inflow from sales revenue during the period
includes an amount to reimburse the business for the use of its fixed
assets. In this respect, depreciation is a source of cash. So depreciation is
added back to net income in the statement of cash flows to arrive at cash
flow from operating activities.
extraordinary gains and losses
No pun intended, but these types of gains
and losses are extraordinarily important to understand. These are nonrecurring,
onetime, unusual, nonoperating gains or losses that are
recorded by a business during the period. The amount of each of these
gains or losses, net of the income tax effect, is reported separately in the
income statement. Net income is reported before and after these gains
and losses. These gains and losses should not be recorded very often, but
in fact many businesses record them every other year or so, causing
much consternation to investors. In addition to evaluating the regular
stream of sales and expenses that produce operating profit, investors
also have to factor into their profit performance analysis the perturbations
of these irregular gains and losses reported by a business.
gross margin, or gross profit
This first-line measure of profit
equals sales revenue less cost of goods sold. This is profit before operating
expenses and interest and income tax expenses are deducted. Financial
reporting standards require that gross margin be reported in
external income statements. Gross margin is a key variable in management
profit reports for decision making and control. Gross margin
doesn’t apply to service businesses that don’t sell products.
negative cash flow
The cash flow from the operating activities of a business
can be negative, which means that its cash balance decreased from
its sales and expense activities during the period. When a business is
operating at a loss instead of making a profit, its cash outflows for
expenses very likely may be more than its cash inflow from sales. Even
when a business makes a profit for the period, its cash inflow from sales
could be considerably less than the sales revenue recorded for the
period, thus causing a negative cash flow for the period. Caution: This
term also is used for certain types of investments in which the net cash
flow from all sources and uses is negative. For example, investors in
rental real estate properties often use the term to mean that the cash
inflow from rental income is less than all cash outflows during the
period, including payments on the mortgage loan on the property.
net income (also called the bottom line, earnings, net earnings, and net
operating earnings)
This key figure equals sales revenue for a period
less all expenses for the period; also, any extraordinary gains and losses
for the period are included in this final profit figure. Everything is taken
into account to arrive at net income, which is popularly called the bottom
line. Net income is clearly the single most important number in business
financial reports.
profit
The general term profit is not precisely defined; it may refer to net
gains over a period of time, or cash inflows less cash outflows for an
investment, or earnings before or after certain costs and expenses are
deducted from income or revenue. In the world of business, profit is
measured by the application of generally accepted accounting principles
(GAAP). In the income statement, the final, bottom-line profit is generally
labeled net income and equals revenue (plus any extraordinary gains)
less all expenses (and less any extraordinary losses) for the period. Inter-
nal management profit reports include several profit lines: gross margin,
contribution margin, operating profit (earnings before interest and
income tax), and earnings before income tax. External income statements
report gross margin (also called gross profit) and often report one
or more other profit lines, although practice varies from business to
business in this regard.
sunk cost
A cost that has been paid and cannot be undone or reversed.
Once the cost has been paid, it is irretrievable, like water over the dam
or spilled milk. Usually, the term refers to the recorded value of an asset
that has lost its value in the operating activities of a business. Examples
are the costs of products in inventory that cannot be sold and fixed
assets that are no longer usable. The book value of these assets should
be written off to expense. These costs should be disregarded in making
decisions about what to do with the assets (except that the income tax
effects of disposing of the assets should be taken into account).
Indirect-Method Format
A format for the operating section of the cash-flow statement that
presents the derivation of cash flow provided by operating activities. The format starts with net
income and adjusts for all nonoperating items and all noncash expenses and changes in working capital accounts.
Net Cash after Operations
Cash flow available for debt service—the payment of interest and principal on loans. Generally calculated as cash provided by operating activities before interest
expense.
Pro-Forma Earnings
Reported net income with selected nonrecurring items of revenue or gain
and expense or loss deducted from or added back, respectively, to reported net income. Occasionally
selected nonoperating or noncash items are also treated as adjustment items.
Leverage
The relationship between interest bearing debt and equity in a company(financial leverage) or the effect of fixed expense on after tax earnings(operating leverage).
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