What are the differences between operating expenses and cost of goods sold (COGS)?

In accounting terms, operating expenses (OE) and cost of goods sold (COGS) are both considered expense accounts. In short, they measure different ways in which resources are spent in the process of running a business. They are segregated on an income statement in part to see how much a product's resources cost versus how much it costs a business to turn those resources into a consumer good.

When an income statement is generated, cost of goods sold and operating expenses are shown as separate line items subtracted from total sales in order to reflect net profits.

Operating Expenses

Businesses incur several different costs that are independent of the level of sales they produce. For example, a coffee shop still has to pay rent and utilities on its facilities even if nobody buys any of its beverages. On top of those expenses, employees still receive salaries and insurance is still paid. Operating expenses are used by most businesses, since they have recurring costs, such as for travel, that are not directly related to actual goods.

Cost of Goods Sold

A cost of goods sold account (COGS) is not necessarily used by every company. If a company does not maintain an industry, is not involved in construction, or otherwise does not use physical resources in the production or provision of its final goods/services, chances are it does not include COGS on its income statement. This is because COGS sold represents the business expenses that are directly incurred because a transaction has taken place. When the coffee shop sells a coffee, this expense account captures the price of the cup, the coffee sleeve, the water, the processed beans, etc. One very general, though imperfect, way of determining if an expense is a COGS is to ask the question, "Would this have been an expense even if no sales were made?"

Understanding the Difference Between Operating Expenses and Cost of Goods Sold

It might be helpful to use a simplified example to differentiate between cost of goods sold and operating expenses. If you picture a warehouse full of goods, the cost of goods sold includes all of the money spent to create the goods and bring them to the warehouse. The operating expenses represent the other day-to-day expenses necessary to keep the business running.

Payroll can actually be either type of expense depending on the labor involved. For instance, office payroll might include a secretary, an accountant, marketing specialists or janitorial workers. All of these salaries are included as operating expenses, while a commissioned salesperson or assembly line autoworker is directly working towards the saleable consumer good and therefore is included in the cost of goods sold expense.

There are more expenses captured on the income statement - Read Fundamental Analysis: The Income Statement and How Operating Expenses Affect Profit.