What are operating expenses?

Operating expenses are the indirect costs of running a business that aren't directly tied to service delivery. For professional service firms, operating expenses (also called overhead or SG&A - Selling, General & Administrative) include rent, marketing, software, administrative salaries, insurance, office supplies, and professional services. Operating expenses appear on the P&L below gross profit and are subtracted to calculate operating income. A consulting firm with $100,000 monthly operating expenses and $250,000 gross profit has $150,000 operating income.

Key characteristics of operating expenses

• Indirect costs: Not directly tied to specific client projects or service delivery

• Categories: Facilities, marketing & sales, technology, administrative, professional services

• Mostly fixed or semi-fixed: Don't fluctuate proportionally with revenue

• P&L placement: Between gross profit and operating income

• Target range: Well-run service firms keep operating expenses under 25% of revenue

Why operating expenses matter for service firms

Operating expenses determine whether gross profit converts to operating profit. A firm with a substantial 55% gross margin but 40% operating expenses has only 15% operating margin. Controlling operating expenses enables profitable scaling: reducing operating expenses from 28% to 22% of revenue adds 6 points to operating margin. Comparing operating expense categories to benchmarks identifies overspending: spending 8% of revenue on marketing when the industry average is 5% signals potential waste. Operating expense trends reveal efficiency: maintaining $150,000 monthly operating expenses while growing revenue from $600,000 to $900,000 improves the operating expense ratio from 25% to 17%.

Example: Operating expenses breakdown and analysis

Monthly operating expenses:

Facilities & occupancy:

• Office rent: $12,000

• Utilities: $1,800

• Cleaning & maintenance: $600

• Subtotal: $14,400

Marketing & sales:

• Digital advertising: $5,200

• Content creation: $3,800

• Events & sponsorships: $2,500

• Sales commissions: $4,200

• Subtotal: $15,700

Technology & software:

• QuickBooks, project mgmt: $3,200

• Microsoft 365: $1,400

• Other SaaS tools: $3,600

• Subtotal: $8,200

Administrative & overhead:

• Admin staff salaries: $22,000

• Office manager: $8,500

• Benefits (admin staff): $4,600

• Payroll taxes (admin): $2,330

• Subtotal: $37,430

Professional services:

• Accounting & bookkeeping: $2,200

• Legal services: $1,800

• Insurance: $3,200

• Bank fees: $450

• Subtotal: $7,650

Other operating:

• Office supplies: $800

• Meals & entertainment: $1,200

• Training & development: $2,400

• Miscellaneous: $600

• Subtotal: $5,000

• Total operating expenses: $88,380

• Monthly revenue: $485,000

• Operating expense ratio: 18.2%

Benchmarking:

• Industry target: Under 25% of revenue ✓

• Best-in-class: 15-20% of revenue ✓

• Current performance: On target

Largest categories:

• 1. Administrative (42% of operating expenses)

• 2. Marketing (18% of operating expenses)

• 3. Facilities (16% of operating expenses)

Efficiency opportunities:

• Renegotiate office lease (save $2,000/month)

• Optimize SaaS subscriptions (save $800/month)

• Outsource admin functions (save $6,000/month)

• Potential savings: $8,800/month = 10% reduction