What Is Occupancy Cost?

Occupancy cost is the expense associated with occupying a premises, such as a manufacturing facility, office, or retail space. It can be a significant contributor to overall operating expenses and it is important to consider this factor in evaluations of a business’ financial standing. Companies also think about this issue when they prepare to relocate or open a new location, as they want to make sure the occupancy cost doesn’t exceed projected revenue or leave the company vulnerable to cash flow problems in the future. A tool called the occupancy cost ratio may be used to help a company calculate a reasonable amount of money to spend on this business expense.

Rent or mortgage payments are an important contributor to occupancy cost, along with property taxes, insurance, and fees that may be required to operate in a given complex or area. In addition, a business may have fitting costs associated with installing equipment and supplies. Marketing to attract people to a location can be a consideration for retail occupancy cost, as the business wants to make people aware the store exists. If a store is in a remote area, more money needs to be spent on marketing to draw customers.

Some costs are fixed, while others may be more flexible. Utilities can shift from month to month, as can periodic expenses like paying a landscaper or commissioning decorating services. Some stores may decorate for holidays, for example, in which case this is part of the occupancy cost because the decorations are used to make the space more appealing to customers. All of these costs can be added up to determine how much money a company spends, or expects to spend, on a given location.

To find the occupancy cost ratio, this number can be divided by sales. High ratios can indicate that a company may be at risk of cash flow problems in the future, because the money brought in by sales closely approaches the expense of keeping a facility going. Lower ratios show that the company is spending a smaller fraction of its sales on occupancy, and thus has money available to manage other business expenses. In addition, the company may be able to invest in development and other activities to grow over time.

Internal financial reports may discuss occupancy cost and ways to control it if there are concerns about company expenses. It can also be a subject of interest when a company applies for loans, as financial institutions want an assurance that a company can afford the cost of debt service. Annual reports and similar financial disclosures contain this information as well, for the benefit of investors who want more information about the company’s operating expenses.