What are operational costs? A plain guide for UK owners

Key takeaways

Operational costs are the day-to-day costs of running a business: wages, premises, software, customer service, administration and marketing. They recur every month whether or not you make a sale. For most UK service businesses, people are the largest share, which is why lowering the cost of routine work has the biggest effect.

• Operational costs recur monthly, with or without sales.
• People are usually the largest operating cost in a service business.
• Capital spending on assets is treated separately from operating costs.
• Sort costs into fixed, variable and stepped before trying to cut them.

What are operational costs?

Operational costs, also called operating costs or operating expenses (opex), are the ongoing costs a business pays to keep trading. In everyday use the term covers everything needed to run the business. In a set of accounts, operating expenses usually sit below gross profit and exclude the direct cost of sales, interest and tax.

Both uses are valid. What matters is that you use one definition consistently, so this year's figure can be compared with last year's.

• How BPO can help businesses reduce operational costs
• Direct vs indirect costs: what small businesses miss

What are the main types of operating cost?

The main types are people, premises, technology, sales and marketing, professional and finance costs, and general administration. A small business can usually fit every line of its profit and loss account into one of these six groups, which makes the total easier to read and to challenge.

• People: salaries, employer National Insurance, pensions, recruitment and training.
• Premises: rent, rates, utilities, cleaning and insurance.
• Technology: software subscriptions, hardware, hosting and telephony.
• Sales and marketing: advertising, agency fees and website costs.
• Professional and finance: accountancy, legal fees and bank charges.
• Administration: postage, supplies, travel and outsourced services.

• Cost drivers: what really moves your operating costs
• Overhead cost per employee in the UK: what to add

How do operating costs differ from capital costs?

Operating costs are used up in the period they are paid for, while capital costs (capex) buy assets that last several years, such as vehicles, machinery or a fit-out. The monthly software subscription is an operating cost. The van is a capital cost, although its fuel, insurance and servicing are operating costs.

The distinction matters for cost reduction because operating costs repeat. A saving of £500 a month is worth £6,000 every year, while a cheaper van is saved once.

• Run-rate savings vs one-off savings: count them correctly

Which operating costs are fixed and which vary?

Fixed operating costs stay the same whatever the workload, such as rent and salaried staff. Variable costs move with volume, such as card fees, packaging or hours bought from a provider. Stepped costs are fixed until a limit is reached and then jump, which is how most small businesses experience hiring.

A business with mostly fixed costs is profitable in busy months and exposed in quiet ones. Moving routine work from salaried roles to a managed service turns part of a fixed cost into a variable one.

• Outsourcing and cash flow: fixed costs to variable
• Step costs: why the next hire is a jump, not a slope
• Operating leverage: why fixed costs make growth risky

How do you work out your own operating costs?

Add up twelve months of expenses from your accounting software, leaving out stock purchases, loan repayments, tax and one-off asset purchases. Group the lines into the six types above. Then divide the total by revenue to see what share of each pound of sales is spent on running the business.

In an illustrative firm with £600,000 revenue, operating costs of £180,000 mean 30p of every pound goes on running the business. The trend over three years tells you more than any single figure.

• 1. Export twelve months of expenses by category.
• 2. Remove stock, tax, loan repayments and asset purchases.
• 3. Group what remains into six types.
• 4. Divide the total by revenue for the same period.

• Operating expense ratio: how to calculate and read yours
• Cost baseline: measure today's cost before you change it

Which operating costs are easiest to reduce?

The easiest operating costs to reduce are the ones tied to repeatable work: customer replies, bookings, invoicing, data entry and reporting. They can be measured per task, done to a written process and run by a managed team at a lower cost per hour. Rent and insurance are harder, because they are contractual and change only at renewal.

Small subscriptions and supplies are simple to trim but rarely add up to much. People costs are where the meaningful savings are, and where careless cuts do the most harm.

• How to reduce back-office costs in a UK small business
• How to reduce customer service costs without slower replies
• Cost-cutting mistakes that end up costing a business more

When is a high operating cost not a problem?

A high operating cost is not a problem when it buys something customers pay for. A firm that spends more on experienced staff and fast replies may charge more and keep clients longer. The test is whether a cost produces revenue, protects it, or neither. Cut the third kind first.

• Cut costs or grow revenue: which should come first?
• Cost cutting vs cost optimisation: which protects profit?

What does this look like in practice?

A pattern we see in UK small businesses: the owner knows the rent and the wage bill to the pound, but cannot say what answering customers or raising invoices costs, because those costs are spread across several people's days. Once the work is logged and priced per task, the largest saving is usually in a place nobody was looking.

• See client work
• BPO Solutions for UK businesses

Operating costs checklist

Use these checks the next time you review your accounts.

• Agree one definition of operating costs and keep to it.
• Group twelve months of spend into six types.
• Mark each line fixed, variable or stepped.
• Calculate operating costs as a share of revenue.
• Compare the share with the last two years.
• Price your three most common routine tasks per task.

• Work out your cost per task before you outsource
• How to run a cost review in a small business

Next step

Send us your six cost totals and your headcount. We will tell you which lines are likely to respond to better processes or a managed team, and which are best left alone.