Operating Expenses

A firm's operating expenses are those costs that do not result directly from the purchase or manufacture of the products it sells. They are generally classed as either selling expenses or general expenses.

Selling expenses are costs that are related to the firm’s marketing activities. They include salaries for members of the sales force, advertising and other promotional expenses, and the costs involved in operating stores. For Northeast Art, selling expenses total $43,000.

General expenses are costs that are incurred in managing a business. They are sometimes called administrative expenses. Typical general expenses are the salaries of office workers and the costs of maintaining offices. A catchcall account called miscellaneous expense is usually included in the general expenses section of the profit and loss account. For Northeast Art general expenses total $36,500. Now it is possible to total both selling and general expenses for Northeast Art. As illustrated in Figure 3.2, total operating expenses are $79,500.

Net Income

Net income is the profit earned (or the loss suffered) by a firm during an accounting period, after all expenses have been deducted from revenues. In Figure 3.2 Northeast's net income from operations is computed as gross profit on sales ($117,000) less total operating expenses ($79,500). For Northeast Art, net income from operations totals $37,500. From this, an interest expense of $2,000 is deducted to give a net income before taxes of $35,500. The interest expense is deducted in this category because it is not an operating expense. It is, rather, an expense that results from financing the business.

Northeast's federal income taxes, based on its pretax income, are $5,325. Although these taxes may or may not be payable immediately, they are definitely an expense that must be deducted from income. This leaves Northeast with a net income after taxes of $30,175. This amount may be used to pay a dividend to stockholders, retained or reinvested in the firm, used to reduce the firm's debts, or all three.