Selling, General and Administrative Expenses (SG&A) is a crucial element of any business’s financial performance. It refers to the costs associated with sales, marketing, and general administration, including salaries, advertising, rent, utilities, and other expenses. For many companies, SG&A expenses represent a significant portion of their overall operating expenses and can impact their financial profitability.
Luis Mocsa, a certified public accountant, the owner of several small businesses and a consultant with American Management Services, argues that KPIs, known as a flash report or dashboard, give business owners and managers an overview of how their companies or individual departments are performing at any given time. If a business owner fails to grasp that, a company may be stuck with its financial problems for quite some time. On the contrary, tracking the right combination of financial KPIs may prove effective for making data-driven decisions and as a result building a successful and modern business.
In this article, we’re looking into SG&A, or selling, general and administrative expenses. This financial KPI is vital in terms of a company’s financial profitability and the calculation of its break-even point. We’ll explore the following points:
1. What is SG&A and why is it important for any business income statement?
2. Components of SG&A expenses
3. Calculating and reporting SG&A expenses
5. SG&A vs COGS (Cost of Goods Sold)
6. SG&A Ratio and financial success of a company
What is SG&A and why is it important for any business income statement?
According to Investopedia, SG&A expenses are made of all the costs of running a business that aren’t related to production of goods and services.
In essence, Selling, General and Administrative Expenses (SG&A) refer to the non-production costs of a business, including expenses related to sales, marketing, and general administration. These expenses are not directly attributable to the production of goods sold, unlike the cost of goods sold (COGS), which represents the direct costs associated with producing the goods sold.
The sales-related costs included in SG&A expenses can vary widely, depending on the nature of the business. For example, a business that relies heavily on direct sales might have high sales commissions and other sales-related expenses. On the other hand, a business that relies more on marketing and advertising might have higher advertising and promotion costs.
Managing SG&A expenses is critical for sustainable profitability. While reducing SG&A costs can provide a quick boost to profits, it’s important to avoid making cuts that could have a negative impact on long-term profitability. For example, reducing marketing and advertising costs might provide a short-term profit boost, but it could also harm sales in the long term.
To manage SG&A expenses effectively, businesses need to track and analyze their costs carefully. This involves understanding the different types of expenses that are included in SG&A, such as rent, utilities, salaries, and advertising costs, and monitoring them closely to identify areas where cost savings might be possible.
It has to be noted that SG&A expenses are reported in a company’s income statement under the expenses section.
Components of SG&A expenses
SG&A expenses are broken down into three categories as seen from the very letters of this initialism: “S” stands for selling, “G” for general and “A” for administrative expenses. We’ll take a closer look at them.
Selling expenses
When it comes to business selling expenses, they’re often divided into direct and indirect costs.
Direct selling expenses occur only when the product is sold. Packing and shipping costs as well as commissions of salespeople, partners or representatives can be a good example of a general direct selling expenses. Direct selling expenses are often variable, unlike other SG&A expenses.
Indirect selling expenses are incurred during the manufacturing process and after the product is finished. Indirect costs are generated before or after sales. Marketing, advertising and promotion expenses, including social media costs are a good example of indirect selling expenses. Base salaries of salespeople and travel expenses refer to this category as well, even if they don’t generate income.
The most typical types of selling expenses include:
- Marketing expenses. They’re related to a company’s product line, services, brand and image. Marketing includes advertising and some companies don’t divide it into separate categories, others do for various reasons. Marketing expenses cover the work of analyst professionals on creating marketing strategies and techniques as well as market research for a particular product or service details.
- Advertising expenses. These expenses come in lots of forms of goods or services promotion starting with good-old TV/Radio ads, billboards all the way to online – social network campaigns and investment in collaborations with influencers .
- Sales expenses. These are made up of salaries and wages of salespeople together with commissions, payroll tax, and benefits.
- Travel expenses. They cover the fares for trips of the staff to various events like trade shows, meetings with clients. These may include transport expenses, accommodation fees, cost of meals, calls, and whatever costs are reasonably needed by a person on a business trip.
G&A, or general and administrative expenses, are called a company’s overhead (important to differentiate from manufacturing overhead, which is a part of COGS). They occur in the daily functioning of a business and aren’t directly tied to any specific function or department in a company. General and administrative expenses are usually fixed regardless of the amount of production or sales over a period of time and normally reported together in the financial statements.
General expenses
General expenses are incurred by a company regardless of the industry or products/services it creates. These expenses keep any business functioning on a daily basis.
General expenses include the following:
- Rent. Any place for an office or headquarters of a company brings its costs. This also includes any other items that aren’t attributed to the manufacturing process, for example equipment costs that aren’t involved in manufacturing, like coffee machines, vending machines or professional cleaning equipment.
- Utilities. These costs cover electricity, water, sewer, or garbage expenses that aren’t part of the manufacturing process.
- Office equipment. This category comprises the cost of equipment like computers, internet connection equipment, printers, telephones or their rent.
- Supplies. This is all that’s necessary for administrative personnel to perform their functions, like stationery.
- Insurance. Any insurance costs that are necessary for operating a business.
Administrative expenses
Administrative expenses can be called the cost of personnel, including internal or external staff, if a company outsources any services. It has to be mentioned here, that these people’s work isn’t directly related to making a product or providing a service by a company. Administrative costs include:
- Accounting payroll;
- Information technology payroll;
- Human resources payroll;
- Legal council;
- Consulting fees.
Calculating and reporting SG&A expenses
Calculating SG&A is rather straightforward as it’s the sum of all non-product related expenses, but there are some financial points to consider along the way:
- Define the expenses that aren’t directly related to the manufacturing of the product.
- Remember about interest and taxes, which aren’t part of SG&A costs as they’re deducted from operating income.
- Determine your reporting period (i.e. a month, quarter, or a year). Bear in mind that nominal accounts, such as expenses, are closed at the end of the accounting year.
- Choose the accounting method wisely – it does matter. While accrual basis accounting recognizes expenses that may have occurred but haven’t been paid for, cash basis accounting will only consider expenses that have been paid for.
The most important thing in SG&A calculation is to define which costs are to be added into the category. Even though Excel is more familiar for most people, this procedure is way simpler when using accounting software which automatically categorizes expenses based on the initial setup. Business accounting systems or software like Synder are able to not only categorize and sum up all the expenses your business incurs in different accounts but also give visualized information on your goods sold, how your metrics, in our case expenses, increase or decrease and help you with business management in general. The following pictures reflect how payment processing fees are changing over time.
Business Insights allows to accumulate, analyze and visualize business data effortlessly with the help of the following features:
- Hourly multichannel data imports;
- Sales analytics;
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- Customer cohort reports;
- Cross platform e-commerce KPIs.
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SG&A is reported in the section of expenses on a company’s income statement.
Net/total revenue is always found at the top of the income statement, then COGS is deducted to get the gross margin or gross profit. Then there comes the section of operating expenses with SG&A, R&D and any other expenses that are listed below the gross margin. Operating/net profit is the result of deduction of these expenses from the gross margin/profit. Some expenses, such as interest expense or tax expense, are reported below operating income.
Learn more about income tax returns.
SG&A vs Operating expenses
When it comes to the difference between SG and operating expenses, often there’s none, especially in the way many companies report them on the income statement. What’s different is the degree of granularity when reporting operating expenses. This degree depends on the size of the company.
Larger companies often separate the components of SG&A and find it useful for tracking purposes. Thus, selling, general and administrative categories come separate on their income statement, while smaller companies may file SG&A or even operating expenses, meaning all the expenses necessary to run a business and not related to making a product or a service.
There are also a few specific categories that are part of operating expenses but are excluded from SG&A. For example, R&D, or research and development costs, are often not included in SG&A, as well as depreciation costs. Both categories are separately reported in the same section Operating Expenses of the income statement as SG&A.
SG&A vs COGS (Cost of Goods Sold)
In financial modeling SG&A and COGS represent different categories of expenses.
COGS or COS (cost of services, the term that works for service companies) represent all the costs directly associated with producing a product or delivering a service, while SG&A cover all the expenses that aren’t directly attributed to the manufacturing process or creating a service.
It has to be said that there are no direct regulations from GAAP and the accounting department of a company decides what should go into COGS and what should go into SG&A. This seems easy at first glance, but in practice there are some ambiguous financial situations. For example, the cost of the materials for making the goods, and the wages of the people making them are directly related to the final product for sale, so they go into COGS. There’s no doubt here as COGS by definition includes direct labor costs and any direct material costs associated with the production process. On the contrary, the salary of the human resources manager and the cost of supplies used by the sales department go into SG&A.
But sometimes this line of division becomes so thin that it’s hard to decide. What do we do with the salary of managers of a company or quality supervisors? GAAP doesn’t say “yes” to one and “no” to the other unfortunately and companies use GAAP guidelines, a logical approach to apply them according to their particular situations. The key moment in management is to apply these guidelines logically and consistently so that all the expenses end up under some category.
SG&A Ratio and financial success of a company
SG&A ratio may help to estimate non-product related costs over a period of time and clearly see the tendency, because just growing SG&A might be a very positive thing, while growing SG&A ratio is a signal to look into the expenses.
The SG&A ratio is the relationship between SG&A and revenue or the expense expressed as a percentage of total sales. The SG&A ratio formula is:
SG&A Ratio = SG&A / Total Revenue
This indicator shows what percentage of a dollar earned is spent on SG&A expenses.
If we take an example of a company with $3 million in SG&A and $15 million in total revenue, we would get SG&A ratio of 20%, which means that every dollar of revenue gives $0.20 on SG&A expenses.
3,000/15,000=0.2 or 20%
Tracking SG&A ratio over time allows us to predict future expenses and take some steps in case of their fast increase. It’s clear that the lower this ratio is, the better it’s for the company. SG&A ratio is compared to the average benchmark in the industry, because this indicator varies a lot.
For example, the SG&A ratio for manufacturers can be around 20% of revenue, while in healthcare it can be up to 50% of revenue. Reducing costs is never complete without attempts to minimize SG&A expenses. According to the Deloitte article “Selling, General & Administration (SG&A) Cost Reduction Focus”, finding ways to lower SG&A costs goes a long way toward cutting overall expenses. Those who succeeded in such attempts advise to focus on the following points:
- Reassign staff from transactional to more value-added work, like planning, decision support and business, performance management;
- Lower indirect expenses company wide (procurement and travel for example);
- Create a flexible cost structure.
Cutting SG&A costs should be systematic and based on opportunity assessment.
Bottom line
Tracking SG&A and generally knowing the numbers is a must for an aspiring businessman, but it’s even more important to make use of these numbers by taking necessary steps based on data-driven decisions, which demands analytical skills and experience. At the same time the process of gathering business information and turning it into visually perceptible sources for such analysis is streamlined by a good business accounting software. A good combination of Business Intelligence technology and management talent can work wonders.
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