Selling, general & administrative expenses (SG&A), also known as operating expenses, are the costs involved in daily business operations.
The two main categories of expenses on an income statement are the cost of goods sold (COGS) and selling, general, and administrative (SG&A) expenses. COGS is the expense that most directly drives revenue and refers to the direct costs of manufacturing goods sold.
SG&A includes most other costs related to running a business aside from COGS. These costs are not related to specific products, so they are categorized separately from the cost of goods sold (COGS) on the income statement. SG&A expenses are sometimes referred to as period costs since they relate to the time period in which they are incurred, and they do not relate directly to production.
What is included in SG&A expense?
SG&A expenses include most expenses related to running a business outside of COGS. This includes salaries, rent, utilities, advertising, marketing, technology, and supplies not used in manufacturing. Some of the most common expenses that do not fall under SG&A or COGS are interest and research and development (R&D) expenses.
SG&A can be broken down into selling expenses and general and administrative expenses.
Selling expenses are the costs a business incurs in selling, distributing, or marketing a product. These expenses may be direct or indirect.
A direct selling expense occurs whenever a unit is sold. For example, when a unit is sold, there may be packaging and shipping costs and sales commission payable to the salesperson. Unlike most SG&A expenses, these expenses are variable.
Other selling expense is indirectly related to the number of units sold. Rather, these are expenses incurred throughout the manufacturing process to earn more sales, such as base salaries of salespeople, marketing, and out-of-pocket travel expense.
General and administrative expenses
General and administrative expenses include most daily expenses that a business incurs in operations, whether it produces goods and generates revenue or not. These expenses can also be referred to as overhead and include rent, utilities, insurance, salaries such as accounting and human resources, technology, and supplies other than those used in manufacturing.
How does SG&A appear on the income statement?
On the income statement, total revenue is shown and reduced by COGS to arrive at gross profit. This shows how much revenue remains to cover operating expenses and hopefully still leave a profit.
SG&A expense is listed below gross profit, followed by other expenses that do not fall under SG&A or COGS, such as financial expenses which do not directly relate to central operations. After all these expenses are deducted from revenue, profit or loss is what we call net income, quite literally, “the bottom line" on the income statement.
Why is SG&A a useful number?
SG&A expenses are an important benchmark as to the company's break-even point. Regardless of sales, a business needs to cover this mostly fixed overhead cost before it can begin to turn a profit, so understanding SG&A is important for management to understand.
SG&A expense and its revenue ratio play a key role in explaining company profitability. Companies and investors often use a ratio that compares SG&A expense with sales revenue as one way to measure a company's financial health. If the ratio is too high or increases with time, this may indicate difficulties sustaining profitability.
After mergers or in times of financial hardship, SG&A expense is the first area that management would examine to cut costs without impacting manufacturing or sales. At the same time, companies need to act wisely in making these decisions. Aggressive cuts in spending may yield short-term improvements while resulting in a long-term decline in revenue.
SG&A expense ratios vary widely by industry and should therefore only be used in comparison with like industries. Pharmaceutical and healthcare have some of the highest SG&A expenses as a percent of revenue, while energy typically has a much lower ratio.
Are SG&A expenses tax deductible?
As with any ordinary and necessary business expense, SG&A expenses are deductible in the year that they were incurred.
SG&A expense represents a company's non-production costs in selling goods and running daily operations. Properly managing and understanding SG&A is crucial to control costs and sustain long-term profitability.
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