How Operating Expenses and Cost of Goods Sold Differ?

Operating expenses (OPEX) and cost of goods sold (COGS) are separate sets of expenditures incurred by businesses in running their daily operations. Consequently, their values are recorded as different line items on a company's income statement. But both of these expenses are subtracted from the company's total sales or revenue figures.

Operating Expenses

Operating expenses refer to expenditures that are not directly tied to the production of goods or services. Typically, selling, general, and administrative (SG&A) expenses are siloed under this category, as a separate line item. Examples of operating expenses include:

• Rent
• Utilities
• Office supplies
• Legal costs
• Sales and marketing
• Payroll
• Insurance

A company must shrewdly budget for its operating expenses while maintaining its competitive edge. After all, these costs are incurred regardless of sales figures. For example, a donut shop must continue paying rent, utilities, and marketing costs, regardless of the number of French crullers it moves in a given week.

Cost of Goods Sold

Cost of goods sold refers to the business expenses directly tied to the production and sale of a company's goods and services. Simply put: COGS represents expenses directly incurred when a transaction takes place. When the coffee shop sells a double espresso, COGS accounts for the price of the to-go cup, the protective sleeve, the coffee filter, the water, the processed beans, and so forth. Examples of COGS include: 

• Labor directly tied to production
• Direct materials needed for the production of goods and services
• Taxes on the production facilities

In retail, COGS includes payment for merchandise purchased from suppliers and manufacturers.

Example of Operating Expenses & COGS

The following statistics were taken directly from J.C. Penney Company's 2017 income statement:

• Total revenues were $12.5 billion.
• COGS, listed as a separate item, totaled $8.1 billion. 
• SG&A was $3.5 billion.
• Total operating expenses were $12.4 billion. 

Payroll Ambiguity

Interestingly, employee payroll can be classified as either type of expense, depending on the specific type of labor involved. Office payroll for secretaries, accountants, marketing specialists, and custodial staff would be classified as operating expenses. But payroll for an assembly-line auto worker would be directly tied to production, and would likely be categorized as a cost of goods sold.

The Bottom Line

If unclear whether or not an expense falls under COGS, simply ask: "Would this expense have emerged even if no sales were generated?" If the answer is "yes," then this expense isn't part of COGS. For example, with a warehouse packed with inventory, COGS includes the money spent creating the goods and transporting them to the warehouse. Contrarily, the costs of keeping that warehouse running, such as rent and utilities, are operational expenses.