Operating Expenses

Your operating expenses (sometimes abbreviated as OPEX) are the ones that are ‘fixed’ in a sense that they (unlike all previous variable expenses) are incurred regardless of the dollar amount of sales (or units sold or manufactured or purchased for resale).

Operating expenses include marketing expenses (related to target market research and analysis, analysis of competition, brand and product management, etc.), strategic planning, legal services, human capital (with the exception of salespeople and those providing direct manufacturing labor).

There are essentially three key issues in managing your OPEX:

First, you have to make a proper distinction between your OPEX and CAPEX (capital expenditures). To efficiently conduct your business, you need both and both are a form of investment from financial value standpoint.  

However, there is a major accounting difference: while OPEX are expenses and therefore go to your P&L, your CAPEX are your assets and therefore go to your balance sheet and are depreciated (or amortized). Which might have serious tax consequences (both expenses and D&A reduce your tax base, but in a very different way) and therefore might significantly influence your free cash flows and financial value.

Therefore, the issue of this differentiation is a serious one and must be managed seriously and responsibly. Sometimes, this is easy. For example, the purchase of a photocopier involves CAPEX, and the annual paper, toner, power and maintenance costs represents OPEX. In some other cases, it is not – and will require services of a highly competent and experienced accountant.

The second issue is similar to the one that I mentioned when discussing your COGS. True, your OPEX – like your COGS - need to be lean (both necessary and sufficient). In other words, no fat, just good lean meat. However, you must cut your OPEX (which in most cases are no lean at all) very carefully - in order not to cut meat with the fat. In which case quality of your goods and services will go down, sales will fall, risks will go up and as the result, your free cash flow, and your financial value will suffer.

The third very important issue is proper allocation of your OPEX to your products, brands, IVC, projects – all objects that generate financial value and need a financial valuation model to estimate this value. Obviously, you can not build an accurate valuation model without an accurate cost section.