Operating costs are the sum of a business' fixed costs or overhead plus its variable costs. Calculating operating costs tells you how much your business spends to produce goods and services for customers. You can use operating costs to estimate your company's breakeven volume, meaning the number of units you must sell before you start making a profit. The term "operating costs” is used somewhat differently for certain tax purposes, such as figuring the expenses of operating vehicles or a home office.
Elements of Operating Costs
Calculating operating costs requires only that you add up the expenses that make up your annual fixed costs and your variable costs. Fixed costs are the expenses the business incurs even if it doesn’t sell any goods or services. Common fixed costs include rent for office, production and retail space, utilities, salaries and benefits for administrative staff, taxes, fees for licenses, professional certifications, bank charges, interest and depreciation. Variable costs are expenditures directly related to producing and selling goods or services. Examples of variable costs are marketing expenses, sales commissions, shipping, raw materials and direct labor.
Breakeven Sales Volume
Breakeven sales volume is the number of units you must sell to exactly cover operating expenses without taking a loss or making a profit. To calculate breakeven sales volume, subtract the variable cost per unit from the sale price. Divide the remainder into your annual fixed costs.
Suppose you sell widgets at a price of $150 each. Variable costs are $40 per unit and annual fixed costs equal $1.65 million. Subtracting $40 from $150 leaves $110. Divide $1.65 million by $110 and you find your annual breakeven sales volume is 15,000 widgets.
Operating Costs – Vehicles
Small business owners and employees frequently use personal vehicles for work-related travel. The Internal Revenue Service allows only work-related driving to be written off. For tax purposes, the operating cost of each vehicle is calculated and a portion allocated as a business expense. Vehicle operating expenses include fuel, depreciation, maintenance and repairs, insurance, ad valorem taxes and interest on vehicle loans.
A mileage log must be kept to document mileage expenses. Business expenses are allocated in the same proportion as the percentage of total mileage that qualifies as business use. If the mileage log shows 75 percent of the mileage is work-related, then 75 percent of vehicle operating costs are tax deductible.
Operating Costs – Home Business
Some small business owners work out of their homes. As with vehicles, business-related home operating costs must be calculated because only a portion of the expense of running a home is tax deductible. Home operating expenses include rent or mortgage interest, utilities, property insurance, taxes, repairs and maintenance.
Home office deductions are limited to a proportion of operating costs equal to the percentage of floor area that is used exclusively for business purposes. Thus, if 20 percent of the area of a home is set aside for business use, then 20 percent of the home’s operating cost qualifies as a tax-deductible business expense.