A line for selling, general, and administrative (SG&A) expenses appears on a company's income statement. These are the costs it incurs trying to produce sales. They're part of the day-to-day operating costs that keep a firm in business.
- SG&A costs include any expenses related to the operation of the company but not directly linked to producing and delivering its products.
- SG&A costs include rent, advertising, administrative staff salaries, and accounting fees.
- These costs can be fixed, or they can vary in relationship to sales. It depends on the nature of the company and its industry.
- A company's SG&A can tell you a lot about its financial health.
SG&A costs pertain to the overall operation of the company. Selling costs can include advertising, sales commissions, and promotional costs. General expenses would be things such as rent, utilities, office supplies, and insurance. Administrative costs include salaries for staff and executives, as well as fees or salaries for services such as IT, accounting, or attorneys.
In contrast, the cost of goods sold (COGS) is the actual cost incurred to produce and deliver a product. It ranges from the raw materials to make the product, to the shipping costs and taxes required to get it to the buyer.
SG&A Can Be Fixed or Variable Costs
Differences exist between a company that has a mostly variable cost structure and one that has a mainly fixed cost structure.
A firm with high fixed costs is said to have high operating leverage. It has a set amount of costs that it must cover. It then makes a profit beyond that level.
Fixed costs are one of the reasons a firm can fail. Suppose its revenue declines from $2 million to $800,000. That's still a high number by small business standards, but it's not good enough if fixed costs are $900,000.
A variable cost structure is one in which the SG&A costs keep pace with sales. Think of an importer that has only a warehouse and almost no other fixed expenses. It has just a 15% commission that it pays to independent road salesmen. The costs follow up and down as sales vary each month. That protects the business and its shareholders in a down market.
Firms with highly variable cost structures are said to have low operating leverage. They might have more competition, but they can more easily survive painful declines in revenue and cash flow. The business doesn’t have to cover a fixed expense load each month.
Excessive SG&A Spending
High SG&A costs in relation to revenue can be a problem for almost any business. Management often attempts to keep SG&A costs limited to a certain percentage of revenue, but that figure may vary a great deal, depending on sector and industry. It can also vary from company to company. Firms target their own models.
Suppose that a bank invests heavily in its customer service experiences. It spends far more than many other banks. It therefore has higher selling costs on its income sheet, but it also has higher sales. Better customer interaction leads to more deposits. More deposits mean more customer loans. The profitability therefore increases as well, ofsetting those higher costs.
Firms must often reduce SG&A costs through cost-cutting moves, such as employee layoffs, when they grow too large without a rise in sales. The same might happen when sales drop for a long stretch of time.
Many companies have had bloated SG&A costs in the past. They cost shareholders billions in profit. Warren Buffet was shocked in the 1980s to find that one of his investments, television network ABC, was spending $60,000 on florists, as well as providing stretch limos and private dining rooms for its executives. The ABC executives also squandered shareholders' capital through out-of-control expenses. It was later revealed that ABC had artificially padded its earnings by selling the original Jackson Pollack and Willem de Kooning paintings it owned. The sales kept the figures up so the company could avoid cutting spending.
Analyzing the Costs
You might encounter a problem when you're analyzing income statements from two firms in the same industry. Some costs can be either the cost of goods sold or the SG&A expenses. This can make the gross profit margin and the operating profit margin appear to differ, even if the firms are financially identical otherwise.
Look for more detail and insight on cost component classification in the company’s financial statement footnotes. This will tell you if you’re comparing companies on the same basis.