Operating Expenses: Mostly Fixed

Michael Whitman · Trading since 2017, full-time since 2020 · Reviewed 2026-09-06

Operating expenses are the costs of running a business that are not directly attributable to producing what it sold, subtracted from gross profit to give operating income. Most of the total is fixed in the short term, which is the mechanism behind operating leverage.

How it works

A labelled breakdown diagram adding selling, general and administrative costs to research and development to give operating expenses. The headline reads: The cost of running the company, not of making the product. — The cost of running the company, not of making the product. Illustrative figures - not a real company.

Operating expenses are what it costs to be a company, as distinct from what it costs to make the product. Sales teams, marketing, head office, finance, legal, research.

A breakdown diagram showing gross profit reduced by operating expenses to give operating income. The headline reads: It sits between gross profit and operating income. — It sits between gross profit and operating income. Illustrative figures - not a real company.

They sit between gross profit and operating income on the income statement, which is why the two profit figures can move in opposite directions.

A breakdown diagram splitting selling and marketing from general and administrative costs. The headline reads: Selling, general and administrative is usually the largest part. — Selling, general and administrative is usually the largest part. Illustrative figures - not a real company.

Selling, general and administrative is normally the biggest component, and it bundles two quite different things: the cost of acquiring customers, which should scale with growth, and the cost of existing, which should not.

The fixed portion is the whole story

A breakdown diagram splitting operating expenses into a fixed portion and a variable portion. The headline reads: Most of it does not fall when revenue falls. — Most of it does not fall when revenue falls. Illustrative figures - not a real company.

Rent, salaries, systems and premises do not shrink when sales do. That is the defining property of the category, and it produces the effect everything else on this page follows from.

A breakdown diagram showing revenue up twenty percent, operating expenses up five percent, and operating income up forty-five percent. The headline reads: Which is what operating leverage means. — Which is what operating leverage means. Illustrative figures - not a real company.

Operating leverage is that arithmetic. If revenue grows 20% and gross margin holds, gross profit grows 20%; if operating expenses grow 5%, operating income grows far faster than either. The same mechanism runs in reverse in a downturn, and it runs harder, because the fixed costs are still there.

Which is the most useful thing to carry away: a company with high fixed operating costs is a leveraged bet on its own revenue, and the leverage is visible in the accounts before anything goes wrong.

In practice: what to watch

Research spending is an expense that buys the future. Illustrative figures - not a real company.

Research spending is an expense today that is meant to produce revenue later. Accounting requires most of it to be expensed as incurred rather than capitalised, so a company investing heavily reports lower profit than one that is not — and the accounts cannot tell you whether the investment was any good.

A breakdown diagram showing operating expenses cut, operating income rising now, and future revenue unknown. The headline reads: Cutting it raises profit immediately and costs later. — Cutting it raises profit immediately and costs later. Illustrative figures - not a real company.

Which makes it the easiest lever to pull. Cutting research raises this year’s operating income immediately and shows up in revenue several years later, if at all. Profit rising while research as a share of revenue falls is one of the few genuinely readable patterns in a set of accounts.

A breakdown diagram separating recurring operating expenses from a one-off restructuring charge. The headline reads: And one-off charges are parked here most often. — And one-off charges are parked here most often. Illustrative figures - not a real company.

One-off charges land here more than anywhere else — restructuring, impairments, legal settlements. They are disclosed, and they make year-on-year comparisons meaningless unless you strip them out yourself.

As a share of revenue it is comparable; in dollars it is not. Illustrative figures - not a real company.

Always read it as a percentage of revenue. A company that grew expenses 12% while revenue grew 20% is improving; one that grew expenses 12% while revenue grew 4% is not, and the dollar figure is identical in both cases.

A breakdown diagram showing a typical bar's range with the round-trip trading cost subtracted. The headline reads: And the round trip in the shares is two percent of a bar. — And the round trip in the shares is two percent of a bar. Illustrative figures - not a real company.

And trading the shares on any of this is a separate cost: 2% of a median bar’s range per round trip on this site’s shared price history.

The ratio worth tracking is research spending divided by revenue, over several years. A company holding it at 7% through a weak year is funding the future out of a smaller base; a company where it drifts from 7% to 4% while operating income improves has bought this year’s profit with next decade’s products, and the income statement presents the two identically.

The same test applies to selling and marketing. Rising sales spend with rising revenue is a company buying growth, and the question is what it costs per unit of revenue gained. Falling sales spend with flat revenue is a company that has stopped trying. Both look like ordinary cost lines until you divide them by the top line and put five years side by side, which is an afternoon’s work in the filings.

What operating expenses are not

They are not cost of goods sold. That is the cost of the product; this is the cost of the company.

They are not all discretionary. Rent and salaries are contractual in the short term.

They are not comparable in dollars. Only as a share of revenue, and only within an industry.

And they are not always recurring. One-off items sit inside the reported total and have to be removed before comparing years.

When it fails

A breakdown diagram showing revenue growth of twelve percent against expense growth of nineteen percent, with margin falling. The headline reads: Expenses rising faster than revenue is the common failure. — Expenses rising faster than revenue is the common failure. Illustrative figures - not a real company.

Expenses growing faster than revenue is the ordinary way a growth company stops being one. Each year looks like investment; the cumulative effect is a business whose costs have found a level its revenue cannot reach.

The second failure is treating a cut as an improvement. Operating income up because research was cut is a different event from operating income up because revenue grew, and the income statement presents both identically.

A third is ignoring the one-off items. A restructuring charge makes this year look bad and next year look good, and neither figure describes the underlying business.

A fourth is missing the leverage in reverse. A company with high fixed costs loses profit far faster than it loses revenue, and the accounts show that risk clearly before it materialises.

And a fifth is comparing dollars across companies of different sizes, which produces confident conclusions from an arithmetic that does not hold.

The original data

Of the 31,760 trading and investing videos in this site’s corpus, 0 have “operating expenses” in the title, 0 have “operating income”, and 0 have “revenue”. “Earnings” returns 28 videos at a median of 2,375 views; “valuation” returns 9 at a median of 17,868; “index fund” returns 30 at a median of 74,230. The counts are in research/corpus-coverage.json, produced by site/measure_corpus.py.

A breakdown diagram showing research and development cut with operating income rising as a result. The headline reads: They cut research spending and profit rose. Good news? — They cut research spending and profit rose. Good news? Illustrative figures - not a real company.

Thirty videos on index funds at a median of 74,230 views, against 844 on one oscillator at 3,907, is a striking ratio and it points somewhere useful. The subjects with almost no supply are getting an order of magnitude more attention per video than the subjects everyone covers. For a reader that means the scarcity of material about how a company actually earns money is a feature of what gets made, not a measure of how much it matters — and the operating expense line is one of the places where a couple of hours in an annual report tells you something a year of chart study cannot.

Operating income is what is left once these come out. Gross profit is what they come out of. And income statement is the sequence they sit in the middle of.

What I actually do

The line I watch is research spending as a share of revenue, because it is the easiest thing to cut and the cut looks like an improvement for about two years. Profit rising while that ratio falls is one of the few genuinely informative patterns on the income statement.

— Michael Whitman

This page is educational, not financial advice. Test every idea on your own charts before risking money.