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What Is a Net Operating Cost?

Net Operating Cost encapsulates the expenses incurred during the day-to-day operations of a business, minus any revenue generated. It's a financial compass, guiding companies in understanding their operational efficiency. By scrutinizing this metric, businesses can pinpoint cost-saving opportunities and enhance profitability. How does your company's net operating cost measure up, and what could it reveal about your financial health? Let's explore further.
Kenneth W. Michael Wills
Kenneth W. Michael Wills

Net operating cost usually refers to all operating expenses incurred, excluding any capitalized costs. Arriving at the total net operating cost, subtracted from the total net profit, can provide the owner of an asset a good indication of whether it is worth investing time, money and/or resources into it. It also helps an asset owner get a true picture of the total operating cost of the asset, allowing him or her to make cuts to the operating budget where possible, in order to increase overall net profit. This line item in an expense report will take into account a variety of different items, depending on the asset, but generally will focus on the costs that immediately contribute to operations, as opposed to capitalized costs that occur over the long-term.

Quality of an asset is often the driving factor behind net operating costs. For example, older real estate properties tend to incur a higher net operating cost than newer properties. Detrimental to operating costs in older properties are frequent repairs, inefficient usage of utilities, and intensive maintenance expenses. Newer properties, however, tend to have more predictable operating costs, making them easier to control. In the event that operating expenses are not met, overall housing quality suffers, and this usually impacts the profit potential of the property in the form of lower rents or lower resale value.

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Businessman giving a thumbs-up

Accountants often make distinctions between expenses that offer immediate benefits and expenses that offer benefits over the long-term. Capital expenditure is the term utilized for expenses that impacts operations, but result in delayed benefits. Such expenses may include depreciation or physical structures like buildings and plants in a manufacturing firm. Immediate benefits that occur in relation to expenses incurred are referred to as operating costs, and it is these totals that are defined as the net operating cost. Examples may include labor, materials, services, equipment and maintenance.

Operating expenses are totaled and subtracted from the total revenues created from the asset to arrive at the accounting income. On the other hand, capitalized expenditures are not usually subtracted from the total revenues in that period. Instead, accountants will spread those expenses over multiple periods and deduct a portion each accounting period. Another common example of a capitalized expenditure aside from depreciation is amortization. This is used to assign expenses associated with intangible assets, such as trademarks, patents or even proprietary knowledge assets like a recipe, for example.

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