It’s no easy task running a business. Add to that staying competitive and things start to feel even more haywire. But what can help you manage it all is knowing your finances inside and out, being completely aware of the financial aspect of your day to day operations, and understanding the value of every item on the income statement.
Did you know that nearly 60% of small businesses fail within the first five years? Often, it’s due to poor financial management. Understanding the difference between Selling, General, and Administrative expenses (SG&A) and Cost of Goods Sold (COGS) can help you avoid this fate.
Contents:
What is SG&A (Selling General and Administrative)?
SG&A includes all the costs that keep your business running but aren’t directly tied to producing goods. Think of salaries for your administrative staff, marketing expenses, rent for your office, and utility bills. For example, if your monthly rent is $2,000, you spend $1,000 on marketing, and you pay $500 in utilities, your total SG&A for that month would be $3,500 because:
SG&A = Selling Expenses + General & Administrative Expenses
These costs are essential for day-to-day operations. They don’t contribute directly to production but are crucial for keeping everything on track. When you look at your income statement, SG&A or selling general and administrative expenses show up as a separate line item. This helps you see how much you spend on general operations compared to direct production costs.
What is COGS (Cost of Goods Sold)?
COGS covers all the direct costs associated with producing the goods you sell. This includes raw materials, labor for production workers, and any other costs directly linked to manufacturing your products. For instance, if you run a bakery and spend $1,000 on flour, $500 on sugar, and $300 on labor for bakers in a month, your COGS would be $1,800 as:
COGS = Beginning Inventory + Purchases – Ending Inventory
COGS is vital because it directly affects your gross profit—the money left after covering production costs. You need to account for all expenses involved in making or acquiring products for resale when calculating COGS. This understanding is key for setting prices and assessing how efficiently you produce goods.
What are the differences between SG&A and COGS?
You already know that COGS includes only direct costs related to producing goods while SG&A includes all administrative costs necessary for running your business that aren’t directly linked to production. Here are some more main differences between SG&A and COGS:
Contribution to revenue generation
COGS contributes directly to revenue generation through product sales. It reflects the cost of bringing those products to market. Understanding COGS helps you determine your gross profit margin.
For example, if your total sales revenue is $10,000 and your COGS is $4,000:
Gross Profit Margin = (Sales Revenue – COGS) / Sales Revenue: ($10,000 – $4,000) / $10,000 = 0.6 or 60%
On the other hand, SG&A supports revenue generation indirectly. While essential for operations, these expenses don’t directly influence product creation costs. They ensure that your business functions smoothly so sales can happen effectively.
Financial statement representation
On your financial statements, COGS appears right below sales revenue on the income statement. This placement highlights its role in determining gross profit. If your sales revenue is $15,000 and your COGS is $6,000:
Gross Profit = Sales Revenue – COGS: $15,000 – $6,000 = $9,000
SG&A is listed separately below COGS under operating expenses. If your SG&A totals $3,500 for the same period:
Operating Income = Gross Profit – SG&A: $9,000 – $3,500 = $5,500
This distinction shows how much you’re spending on general operations versus production costs.
Now that you understand these differences with examples in mind, let’s look at some financial management considerations that are essential when calculating your SG&A and COGS.
Financial management considerations
Managing your finances effectively requires several strategies related to both SG&A and COGS.
Forecasting
Forecasting is essential for predicting future revenues and expenses. Use historical data to create reliable projections that align with your business goals. For example, if your SG&A expenses have increased by 10% annually, you can project future costs based on this trend. If last year’s SG&A was $50,000, you might forecast $55,000 for the next year. Similarly, analyzing past COGS trends helps you anticipate future production costs. If your COGS has averaged $30,000 over the past few years, you can use this information to set budgets and allocate resources accordingly.
Accurate forecasting allows you to prepare for potential challenges and capitalize on growth opportunities. For instance, if you expect a seasonal increase in sales during the holidays, you can adjust your inventory purchases and staffing levels in advance.
Analyzing trends
Regularly analyze trends in your financial statements. Look for patterns in both SG&A and COGS over time. If SG&A expenses rise faster than revenue growth, say from an average of 10% of sales revenue to 15%, it may signal inefficiencies that need addressing. For example, if your revenue is growing at 5% but your SG&A expenses are increasing at 15%, it could indicate that your administrative costs are outpacing your sales growth.
By identifying these trends early, you can take corrective action before they impact your bottom line. This might involve reviewing marketing strategies or cutting back on unnecessary administrative expenses.
Controlling costs
Keep a close eye on both types of expenses for better cost control. Identify areas where you can cut unnecessary administrative expenses or streamline production processes to enhance profitability. For instance, if you notice that your marketing expenses have increased significantly without a corresponding rise in sales, it might be time to reassess your marketing strategy.
Implementing strict oversight on spending ensures that resources are used efficiently. Regularly review your SG&A and COGS to pinpoint cost drivers and optimize operations. If you find that certain overhead costs are consistently high, consider renegotiating contracts or finding more cost-effective suppliers.
Benchmarking
Compare your SG&A and COGS ratios with industry standards to gauge your performance. If industry benchmarks show that companies similar to yours have a lower SG&A percentage, say 8% instead of your 12%, this could indicate areas for improvement. Analyzing these ratios helps you understand where you stand relative to competitors.
Benchmarking also allows you to identify best practices within your industry. If other companies manage their SG&A more efficiently, investigate their methods and consider implementing similar strategies in your own operations.
Wrapping-up
Understanding the differences between SG&A and COGS is essential for effective financial management in your business. By tracking these types of expenses accurately through diligent calculations like those shown above you’ll make better decisions that enhance profitability.
If you’re looking to streamline this process while ensuring accuracy in tracking both types of expenses across platforms like QuickBooks, Xero or Sage Intacct, consider using Synder, an accounting automation tool designed specifically for ecommerce and subscription-based businesses like yours!
Synder integrates seamlessly with over 30 popular sales and payment platforms, including PayPal and Shopify, consolidating all your payment channels into one unified system. Start optimizing your financial management today, sign up for a 15-day free trial or book a spot at Synder’s Weekly Public Demo!
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