Operating Costs Defined

What are total operating costs?  Operating costs are costs incurred by a firm for running the entire company.  This cost includes Sales, General, & Administrative (SG&A)Research & Development (R&D)Depreciation & Amortization (D&A).  The combined costs are deducted from Gross Profits to tally Operating Profits.

The accumulation and deduction of costs from top to bottom for gross revenues, Costs of Goods Sold (COGS), Sales, General, & Administrative (SG&A), Research & Development (R&D), and Depreciation & Amortization (D&A), ends with Operating Profits.

Total Operating Costs are inclusive of deducting the depreciation & amortization from short term assets.  However, while D&A are removed from the non-GAAP equation for EBITDA, total operating costs would include SG&A as well as D&A.

Understanding Operating Costs functions

Operating costs can be looked at to determine how efficient a company is from a management, or back-office perspective, versus total revenues.  If a company is cost conscience, their back-office will likely have a low ratio to revenue.

To determine this, an analyst would use total operating costs and divide these over top of gross revenues.  The product of this is a ratio, or a percentage.  This is also a cost ratio.

Ostensibly, the lower the ratio, the better the costs metric for total operating costs is relative to gross revenues.  A firm that has a low cost ratio would be thought to be more efficient and creating revenue versus the costs of generating revenue.

Getting To Operating Profits

Operating Profits are those profits that are the result of what is remaining from gross revenues after Cost of Goods are subtracted (Leaving Gross Profits), and total operating costs deducted from that.  This is total operating profits.

Operating Margins Explained

Unlike operating efficiencies, operating margins show what amount of profits remain after deducting cost of goods sold as well as total operating costs.  It is important to note that operating margins include total operating costs.  This deducts depreciation and amortization (D&A) out from gross revenues.

By including D&A, this sidesteps what EBITDA shows.  This is the main difference.

Operating Efficiencies Explained

Unlike operating margins, operating efficiencies are a metric that are derived by dividing total operating costs over total revenues.  This gives a percentage.  Calculating operating efficiencies will tell an investor or analyst how well a firm is performing from the “back office” perspective relative to total revenues.

This metric tells how well and on what proportion the back office is able to produce revenue.  The lower the resulting metric the more proficient the firm is at generating revenue.

The advantage to using operating efficiencies as a metric allows an analyst the ability to measure certain metrics individually.  Operating efficiencies takes out gross margins and may help to determine how well a company is performing versus others.

Comparing firms to one another via operating efficiencies shows that a company may be competitively advantaged versus others.

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