What it means
Every business has a core that makes and sells things and a layer around it that keeps the organisation running. Administrative expenses are the cost of that layer.
They do not rise and fall with each unit sold, so a business that doubles its sales does not need to double its finance team or its office rent, which is where the operating leverage of growth comes from. Equally, a business whose sales halve is still paying the same rent and salaries, which is why downturns hit profit so hard.
The classification matters for analysis. Separating administrative costs from cost of sales and from selling costs lets a reader see the gross margin of the product, the cost of winning customers and the cost of the corporate structure as three distinct lines.
A rising administrative expense ratio, administrative costs as a percentage of revenue, signals either that overhead is growing faster than the business or that revenue is falling and the overhead has not been adjusted. Comparing the ratio with competitors shows whether a company is carrying more structure than its rivals.
Where a cost belongs is sometimes a judgement. The salary of a factory manager is a production overhead and goes into cost of sales; the salary of the chief financial officer is administrative.
A warehouse's rent is a distribution cost; the head office's rent is administrative. IT costs may be split among all three depending on what the systems support.
Consistency from year to year matters more than the exact boundary, and companies disclose their classification policy. Administrative expenses are where efficiency programmes usually begin, because they are visible, largely discretionary in the medium term and do not affect the product.
The risk is cutting the functions that protect the business: a finance team too small to control cash, an HR function too thin to retain staff, or an IT budget too low to keep systems secure. The aim is an administrative cost base that is lean but adequate, and that scales more slowly than revenue.
In practice
Real-world examples.
Example
A manufacturer's SG&A note shows administrative expenses of $8 million, including $2.5 million of head office salaries, $1.2 million of audit, legal and consulting fees and $900,000 of office costs.
Example
A start-up that outsources its finance, HR and legal functions keeps administrative expenses at 6% of revenue, half the level of an established competitor with in-house departments.
Example
A retailer merging with a rival identifies $30 million of duplicated administrative costs, mainly two head offices and two finance systems, as the largest source of merger savings.
Think of it
“Administrative expenses are the costs of running the back office-management, accounting, HR, and general overhead.
Formula
Calculation
Administrative Expense Ratio = Administrative Expenses / Revenue x 100%
Operating Profit = Gross Profit minus Selling Expenses minus Administrative Expenses
Worked example. A regional distribution company reports two years of results:
Year 1: revenue $12,000,000; gross profit $3,600,000; selling expenses $900,000; administrative expenses $1,440,000
- Administrative expense ratio = $1,440,000 / $12,000,000 = 12.0%
- Operating profit = $3,600,000 minus $900,000 minus $1,440,000 = $1,260,000 (10.5%)
Year 2: revenue $13,200,000 (up 10%); gross profit $3,960,000; selling expenses $990,000; administrative expenses $1,716,000
- Administrative expense ratio = $1,716,000 / $13,200,000 = 13.0%
- Operating profit = $3,960,000 minus $990,000 minus $1,716,000 = $1,254,000 (9.5%)
Revenue grew 10% and gross profit grew 10%, but administrative expenses grew 19%, and operating profit fell slightly. The company added a head office layer faster than it added sales. Had administrative expenses been held at 12% of revenue ($1,584,000), operating profit would have been $1,386,000, a 10% increase in line with revenue.
Breakdown of the year 2 administrative expenses, to see where the growth came from: salaries $1,050,000 (up $180,000 with two new managers), office rent $240,000 (unchanged), professional fees $190,000 (up $60,000 for a systems project), insurance $96,000 (up $16,000), IT $140,000 (up $20,000).Case study
Seen in the real world.
A professional services firm with 120 staff had grown its administrative headcount from 8 to 22 in four years, adding assistants, coordinators and a "chief of staff" for each of its four division heads. Administrative expenses had risen from 14% to 23% of revenue, and operating margin had fallen from 18% to 9% while fee income grew steadily. The partners commissioned a zero-based review in which every administrative role had to be justified from scratch against the work it performed.
The review found three people doing manual reconciliations that the accounting system could automate, two roles that existed to manage the diary conflicts created by the other two, and a hiring process that took 14 people's time for each vacancy. The firm reduced administrative headcount to 14 through attrition and redeployment, invested $80,000 in systems, and set an administrative expense ceiling of 15% of revenue with any increase requiring partner approval. Margin recovered to 16% within eighteen months.
Watch out
Common mistakes.
- Letting administrative costs grow in line with revenue. They should grow more slowly; that is where scale economies live.
- Cutting administrative functions without understanding what they protect. A weak finance function costs more in errors and lost cash than it saves in salaries.
- Burying administrative costs in cost of sales or vice versa, which hides the trend in each.
Questions
People also ask.
What is the difference between administrative and operating expenses?
Administrative expenses are one category of operating expenses, alongside selling and distribution costs and, in some presentations, research and development.
Are administrative expenses fixed costs?
Mostly, in the short term. Rent, salaries and subscriptions do not change with sales volume, though they can be changed by management decision over time.
What is a normal administrative expense ratio?
It varies widely by industry and size, from under 5% in lean distribution businesses to over 20% in professional services and technology firms. The trend and the comparison with peers matter more than the level.
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