Why SG&A Costs are Relevant
In reporting expenses on an income statement, there are various expenses incurred that are not directly related to production. The primary reason tracking these expenses separately is so important is because they are independent of variable production volume, and as a result, their overall impact on the organization is largely fixed (as opposed to variable, per unit cost). This has some strategic implications.
How SG&A Costs are Calculated
Most of these expenses tend to revolve around indirect aspects of production. One way to picture this is to consider the supporting infrastructure around the core process: the office space (and the associated utility costs), for example, or the salaries of support staff and management. While the potential list of expenditures for this line item is extensive, the following are some common expenses incurred that would be filed under SG&A:
- Salary/Payroll (i.e. salary not directly related to variable production)
- Overhead
- Administration
- Software
- Rent
- Insurance
- Maintenance
- Commissions
- Utilities
What SG&A Implies
By separating these expenses from the production expenses, it provides investors, management, and other stakeholders with insights surrounding the efficiency of organizational operation. Organizations with an SG&A budget that represents a high percentage of their overall expense would be assumed to be less efficient than a similar organization producing a similar amount of revenue with a lower SG&A.
For example, company A has quite a few highly paid managers and executives on their team. They also use cutting edge software to manage the production process, which has a high annual cost. They produce slightly more revenue than their close competitor, company B (20% more revenue per annum). They create a net income of 2% on an annual basis.
Company B, on the other hand, has few managers and executives and relies on a slightly slower yet much cheaper software solution for managing operational output. As a result, they make 20% less than company A each year, but their expenses are 40% less than company. As a result, the produce a net income at almost 30% of revenue.
Company A is clearly producing more volume and making bigger strategic investments in IT, however company B is leveraging their resources better in terms of profitability by minimizing their SG&A and focusing more exclusive on investing in their production efficiency.
Income Statement
This image shows a basic income statement, including a line item for SG&A. This demonstrates where it is (under operating expenses).