What it means
Think of the costs in a business as falling into two buckets. The first is the cost of producing what is sold, such as materials and factory labour, which is reported as cost of goods sold.
SG&A is the second bucket: everything else needed to find customers, serve them and keep the company running. Selling expenses include sales team pay and commissions, advertising, trade shows and delivery to customers in some businesses.
General and administrative expenses include executive and finance salaries, office rent, utilities, legal and audit fees, software and insurance. Research and development, depreciation and interest are often reported on separate lines, although practice varies between companies.
SG&A is read as a percentage of revenue so that companies of different sizes can be compared. A rising ratio can mean the business is spending more to win each sale, or that revenue has fallen while overheads stayed fixed.
A falling ratio can signal good cost control or economies of scale, as growing revenue is spread across a relatively stable base of overheads. Managers use SG&A for budgeting, for benchmarking against competitors and for setting cost-reduction targets.
Investors use it to judge operating leverage, which means how much extra profit each additional dollar of revenue produces. Cutting SG&A can lift profit quickly, but cutting too deeply in sales and marketing may damage future growth.
The nuance is that SG&A is partly fixed and partly variable. Rent and salaries do not move with every sale, while commissions and shipping costs do, so the same ratio can mean different things in different businesses.
Comparisons are most useful within one industry, since a software firm and a supermarket have very different cost structures.
In practice
Real-world examples.
Example
A retail chain reviews its income statement and sees SG&A at 28% of revenue, compared with 25% at its closest rival. The finance team breaks the figure into store payroll, marketing and head-office costs to find where the gap comes from.
Example
A software company hires 15 new salespeople ahead of a product launch. Its SG&A rises sharply in the quarter, and the CFO explains to the board that the cost was planned and should show up as higher revenue in later quarters.
Example
A manufacturer faces a downturn and cuts discretionary SG&A such as travel, consulting and trade shows. It protects the sales team so that it can respond quickly when demand recovers.
Formula
Calculation
SG&A ratio = SG&A expenses / revenue x 100
Suppose a distribution company reports revenue of $8,000,000 for the year. Its selling expenses are $900,000 and its general and administrative expenses are $700,000, so SG&A is 900,000 + 700,000 = $1,600,000. The SG&A ratio is 1,600,000 / 8,000,000 = 0.20, or 20%. If revenue grows to $10,000,000 while SG&A rises only to $1,800,000, the ratio falls to 1,800,000 / 10,000,000 = 18%, which shows operating leverage at work.Case study
Seen in the real world.
Greenfield Home Goods is an illustrative, fictional company selling kitchenware online and through a few stores. Over three years, its revenue grew from $12,000,000 to $15,000,000, but its SG&A grew from $3,000,000 to $4,500,000, taking the ratio from 25% to 30%.
The finance director split the increase into categories. Digital advertising had grown fastest, with each new customer costing more to win, and the office had taken on a larger lease than it needed.
By renegotiating the lease and shifting spending towards the channels with the best return, the company brought SG&A back to $4,200,000 on revenue of $16,000,000, a ratio of 26.25%. The illustrative lesson was that tracking SG&A as a percentage of revenue, and not just as a dollar total, exposed the problem early.
Watch out
Common mistakes.
- Treating SG&A as the same as total operating expenses, when items such as research and development and depreciation are often reported separately.
- Cutting SG&A to boost short-term profit without checking whether the cuts damage sales or customer service.
- Comparing SG&A ratios across very different industries, when business models make the normal level very different.
Questions
People also ask.
Is SG&A included in cost of goods sold?
No, cost of goods sold covers the direct costs of producing what was sold, while SG&A covers selling and running the business.
Is a lower SG&A ratio always better?
Not always, since a business that underinvests in sales or support may save money now and lose customers later.
Where does SG&A appear in the financial statements?
It appears on the income statement below gross profit, and it is subtracted to arrive at operating profit.
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