Operating Expenses

Where operating expenses sit

A simplified income statement can be viewed as:

Revenue − cost of sales = gross profit − other operating expenses = operating income

The exact labels vary.

Some companies present:

• cost of revenue
• SG&A
• R&D
• depreciation

separately.

Others aggregate more heavily.

Basic example

Assume:

• revenue: $500 million
• COGS: $300 million
• SG&A: $80 million
• R&D: $40 million
• other operating expense: $10 million

Operating income:

$70 million

Every operating-expense category affects the profit available before financing and taxes.

Real 2026 example

A 2026 SEC filing presented operating expenses including:

• research and development: about $1.86 million
• general and administrative: about $4.10 million
• total operating expenses: approximately $5.96 million.^[2]

That example shows how the total is built from distinct expense categories.

Operating expense vs. COGS

COGS is often separated because it is closely tied to goods sold.

SG&A and R&D usually sit below gross profit.

Both are operating economics.

The separation allows investors to distinguish:

• product-level economics
• organizational operating cost

That is why gross margin and operating margin tell different stories.

Fixed vs. variable expenses

Some operating expenses move with sales.

Examples can include:

• sales commissions
• shipping
• transaction fees

Others are more fixed in the short run:

• headquarters rent
• corporate salaries
• software systems

The mix determines operating leverage.

Operating leverage

If revenue rises faster than operating expenses:

operating margin can expand.

If revenue falls while fixed costs remain:

operating margin can compress quickly.

A scalable business has the potential to grow profit faster than revenue once fixed costs are covered.

That potential is not guaranteed.

Cost cutting

Reducing operating expenses can improve current earnings.

Useful cuts eliminate:

• duplication
• excess facilities
• inefficient processes

Dangerous cuts reduce:

• product development
• customer support
• maintenance
• sales capacity

A lower expense base is only better if the business remains competitive.

Restructuring

Companies often record operating charges for:

• layoffs
• facility closures
• reorganizations

Management may exclude these costs from adjusted operating income.

A genuinely unusual restructuring can improve comparability.

Repeated restructurings weaken the argument that the costs are exceptional.

Stock-based compensation

SBC can appear inside:

• SG&A
• R&D
• cost of revenue

Companies often exclude it from adjusted expense measures.

That makes adjusted operating profit higher.

The dilution or cash-funded buyback cost remains economically relevant.

Depreciation and amortization

D&A can be:

• included in cost of sales
• included in operating expenses
• shown separately

depending on presentation.

That affects gross and operating margin comparability.

EBITDA adds the expenses back regardless of where they were classified.

Operating expenses vs. cash operating costs

Accrual accounting creates timing differences.

Examples:

• accrued bonuses
• prepaid insurance
• stock compensation
• depreciation

Reported operating expense is not identical to cash paid during the period.

Operating cash flow helps bridge the difference.

Expense growth can be intentional

A company can increase operating expenses before revenue growth by investing in:

• salesforce
• engineering
• geographic expansion
• systems

Margins may fall temporarily.

The relevant test is whether the spending creates attractive future returns.

Common-size analysis

A useful approach is to express each expense as a percentage of revenue.

Example:

• SG&A: 15%
• R&D: 10%
• other operating expense: 3%

Tracking these percentages over time can reveal where margin change originates.

Common mistakes

"Operating expenses should always decline."

No.

"All operating expenses are fixed."

No.

"Lower operating expense guarantees stronger economics."

No.

"Operating expense equals cash spending."

No.

Decompose operating expenses by category rather than focusing only on the total. Track each line against revenue, identify fixed and variable behavior, separate recurring from adjusted charges and test whether spending produces growth or simply consumes margin.