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What Is OpEx? A Guide to Understanding Operating Expenses

What Is OpEx? A Guide to Understanding Operating Expenses

Biotechs face a unique set of challenges when it comes to managing their finances. They need to invest heavily in research and development to bring new therapies and products to market, but need to be smart with their budgets and manage expenses carefully to stay afloat.

Startups don’t always have an effective way to generate revenue, often relying on external funding and grants to keep operations going instead . However, fundraising is often very difficult. It is even more difficult now. Reduced access to funding and an exceptionally long discovery and development cycle makes keeping track of your expenses even more important.

That said, part of running a company properly is recording operating costs, no matter what industry you’re in. So the information in this short guide applies to all types of businesses. To properly record operating costs, it can be simpler to divide your expenses into different categories. One of these categories is known as operating expenses, or OpEx. You may also see it referred to as operating expenditures.

In this blog post, we'll define operating expenses, explain why they’re essential for biotech companies to understand, compare Opex and CapEx, and provide tips for managing OpEx effectively. We'll also discuss how leasing equipment can be an intelligent OpEx management strategy for smaller biotech companies.

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What are Operating Expenses?

OpEx are the day-to-day costs, or operating costs, a business incurs to run its core operations. These costs can be a one-time payment or recurring payments. Either way, they need to be paid to keep the company running.

Opex can often be referred to as selling, general, and administrative expenses (SG&A), as the two are considered synonymous because they tend to include the same types of expenses. However, each cost can be listed separately from one another on the income statement.

It’s up to a company’s company's management to list the expenses as separate line items, and all depends on how the company wants to break out their operating expenses.

Some examples of operating expenses include:

  • Payroll and employee salaries
  • Research and development
  • Rent for office or lab space
  • Repair and maintenance costs
  • Utilities
  • Office supplies
  • Business travel
  • Sales and marketing costs
  • Accounting and legal fees
  • Property taxes

It might seem like the costs that go into producing a company’s product or service, also known as COGs, would also be considered part of a company’s OpEx, and show up on this list. But they don’t. Why is that?

COGs include things like the cost of direct labor and raw materials, overhead costs for the production facility, and the wages and benefits of the production workers. Anything that goes directly towards making a good or service the company then sells.

Both COGs and OpEx are considered operating costs and are related to a company’s core operations, but OpEx does not include the cost of goods sold a company incurs. Instead, operating expenses represent the remaining, indirect costs that are not included under COGS.

In other words, both COGS and OpEx are important expense categories that impact a company's profitability, but they are reported separately in a company's financial statements. COGS is reported on the income statement as a separate expense item from OpEx, which is also reported on the income statement.

OpEx also doesn’t include things like investments, interest payments, lawsuit settlements, and restructuring costs, which are considered non-operating expenses.

To put it all simply: OpEx includes indirect costs like selling, general, and administrative expenses and excludes direct costs like the cost of goods sold. It does not directly contribute to the production of a good or service, but it is necessary to keep a business running.

OpEx vs. CapEx

OpEx and CapEx differ from one another. They also happen to share some similarities. Let’s review.

Both OpEx and CapEx represent outlays for a company, reducing the business’s net income. And both usually account for something acquired in exchange for cash. This means there is a similar purchasing process that involves things like soliciting bids, contracting, legal review, orchestration of financial payment, and receipt of the purchase. Which makes planning for these expenses somewhat similar.

Even though they may be tracked separately, each type of cost will typically have its own budget, forecast, long-term plan, and financial manager to oversee the planning and reporting of each. In this way, each budget requires strong and effective planning and preparation.

Now, the difference between OpEx and CapEx lies in the types of costs each represents and how they are treated in a company's financial statements. Generally accepted accounting principles (GAAP) in the United States dictate how an expenditure should be reported, which can have long-term financial implications and affect how external parties view the company's health.

OpEx accounts for the day-to-day expenses a company pays to keep the business’s core operations running (e.g., payroll and wages, research and development, etc.). These expenses represent costs that do not hold significantly long-term value according to general accounting principles.

Because of this, OpEx is reported on a company’s income statement and expensed immediately. OpEx does not depreciate or amortize over multiple reporting periods.

In contrast, capital expenditures (CapEx) represent the money spent on acquiring, maintaining, or upgrading services or goods that are expected to provide long-term value to a company. These are usually major purchases.

The most common examples include property, buildings, land, vehicles, and equipment, all of which generally have a long useful life. However, CapEx can also include depreciation, interest expenses, and taxes.

Because of the long useful life of the assets acquired using a CapEx budget, CapEx is reported on the balance sheet, involving depreciation and amortization, both of which are accounted for over a longer period of time.

However, it's not just about accounting treatment. There also tends to be a difference in how management teams approach CapEx and OpEx. Capital expenses are often more expensive and require more time and resources to see the benefits. On the other hand, OpEx is often cheaper and more flexible to incur.

It's also important to understand the strategic approach to each type of expenditure and make informed decisions about their spending. By knowing when to invest in CapEx and when to focus on OpEx, a business can more effectively work towards financial stability and long-term success.

Why are Operating Expenses Important?

Managing OpEx is essential for a biotech company’s financial health and long-term growth potential. Without proper OpEx management, a company can easily find itself in a situation where it’s spending more money than it’s bringing in, quickly leading to financial distress and even bankruptcy.

One example of poor OpEx management in the biotech industry is the case of Theranos, a blood-testing startup that raised millions of dollars in funding before collapsing in a fraud scandal in 2018. One of the company’s key issues (there were many) was its failure to manage its operating expenses effectively. 

According to court filings, Theranos spent over $50 million on operating expenses in 2014 alone, much of which went toward lavish perks for its executives while generating just $100,000 in revenue.

How to Calculate OpEx

One formula for calculating operating expenses (OpEx) is:

    OpEx = Total Expenses - Non-Operating Expenses - Cost of Goods Sold (COGs)

In this formula, "total expenses" represents all of the expenses incurred by a business in the course of its day-to-day operations—those expenses we mentioned above: salaries, rent, utilities, etc.

"Non-operating expenses" refer to the expenses that are not directly related to the core business operations, such as interest expenses, taxes, or one-time expenses.

"Cost of goods sold,” which you’re familiar with by now, represents the direct costs associated with producing or acquiring the goods or services that the business sells.

By subtracting the non-operating expenses and COGS from the total expenses, you can calculate the operating expenses incurred by a business.

You can also use a formula like this:

    OpEx = Revenue - Operating Income - COGs

In this formula, “revenue” represents the total amount of income a business generated by selling its goods or services, and “operating income” represents the amount of profit a business generated after deducting certain expenses.

Another way to think about calculating OpEx is to simply add up all of your operating expenses and exclude any capital expenses or non-operating expenses.

Why Does Calculating OpEx Matter?

Calculating OpEx is important because it can be used to determine your business’s operating income, net income, and profit margin. 

With your operating expenses calculated, calculate your gross profit. This formula is as follows:

    Gross profit = revenue - COGS

From there, you can calculate your operating income:

    Operating income = gross profit - OPEX - depreciation - amortization

With your operating income calculated, you can determine your net income:

    Net income = operating income - interest - taxes

Once you’ve calculated your net income, you can determine your profit margin using the following two formulas:

    Gross profit margin = gross profit / revenue

    Operating profit margin = operating income / revenue

These calculations are important for several reasons. For example, understanding your operating expenses, operating income, net income, and profit margin can give you a clear picture of your business's financial health.

Tracking these metrics can help you identify areas where you are spending too much money, areas where you can cut costs, and areas where you can invest more to increase revenue.

It can also help with profitability. Profit margin is a critical metric that indicates how much profit a business is generating relative to its revenue. By monitoring your profit margin, you can ensure that your business is generating enough revenue to cover your operating expenses and earn a reasonable profit.

Furthermore, you can make more informed business decisions. If your profit margin is low, you may need to explore ways to reduce costs or increase revenue to improve profitability. Similarly, if your operating expenses are high, you may need to find ways to cut costs or optimize your spending to improve efficiency.

Investors and lenders also often look at a company's financial statements to evaluate its financial health and potential for growth. If you’re tracking these financial metrics and can present them in a clear and concise manner, you’ll have an easier time building trust and credibility with potential investors and lenders.

How to Manage OpEx Properly

What can biotech companies do to manage their operating expenditures effectively? In addition to keeping track of and calculating your expenses, here are some tips we’ve compiled:

Set Realistic Budgets

Understand your company’s expenses and revenue streams to set realistic budgets that align with your goals. Be sure to consider both fixed costs (e.g., rent) and variable costs (e.g., marketing expenses), adjusting your budgets based on changes in your business environment.

Prioritize Expenses

Not all expenses are created equal, and it's important to prioritize them based on their importance to the company's success. For example, costs that directly contribute to revenue generation should be prioritized over expenses that are more peripheral to the company's operations.

Analyze Historical Data

Analyzing historical data can provide valuable insights into trends and patterns in operating expenses. By identifying areas where expenses have increased or decreased over time, companies can make informed decisions about where to focus their cost-cutting efforts or where to invest resources for growth.

Implement Cost-Saving Measures

There are many cost-saving measures that companies can implement to reduce operating expenses. Encouraging remote work (if remote work is possible) can reduce the need for expensive office space and utilities. Encouraging employees to carpool or use public transportation can reduce transportation costs.

Benchmark Against Industry Standards

Comparing a company’s operating expenses to industry standards can provide valuable context and help identify areas for improvement. For example, if a company’s expenses are significantly higher than its competitors, it may indicate inefficiencies that must be addressed.

Regularly Review Expenses

Regularly review your company’s expenses to identify areas where you can cut costs or optimize spending. This could involve renegotiating contracts with suppliers, switching to more cost-effective solutions, or reducing unnecessary expenses.

Consider Leasing Equipment

For biotech companies that need expensive equipment to run their operations, leasing can be a smart OpEx management strategy. Leasing allows companies to spread out the cost of equipment over time, making it easier to manage cash flow and avoid significant upfront expenses. 

It also provides flexibility to upgrade or replace equipment, which can be important in a rapidly changing industry like biotechnology.

OpEx Management Is a Critical Part of Running a Biotech

Understanding and managing operating expenses, or OpEx, is crucial for any business looking to maintain a healthy bottom line.

By keeping a close eye on day-to-day operations and carefully monitoring business expenses, companies can identify areas where costs can be reduced without compromising quality or efficiency.

With effective OpEx management, companies can allocate resources for business activities more effectively, improve profitability, and achieve long-term success. So remember, paying attention to your OpEx can be the key to unlocking financial success in your business.

Biotechs, especially early-stage companies, should regularly review their expenses and set realistic budgets to ensure they manage their OpEx. They should also consider leasing equipment to help control costs and improve cash flow. A well-managed budget and an improved cash flow will have a positive impact on overall business operations, ensuring you maintain a healthy cash runway.

By following the above-mentioned guidelines and considering leasing as a cost management strategy, biotech companies can improve cash flow and set themselves up for long-term success.