Founders often hear the term “SG&A expenses” tossed around in board meetings, which stands for selling, general, and administrative expenses. SG&A expenses are essentially the cost of running your company; these are costs unrelated (at least not directly) to production or sales.
Although some refer to SG&A as “overhead costs,” that term has become somewhat synonymous with “unnecessary.” CEOs and founders are frequently told they need to “cut overhead costs,” but that phrase makes it seem like overhead expenses are unimportant.
Why are SG&A expenses important?
Overhead expenses are often beneficial — one obvious example is accounting. Accounting is a crucial business function, and it’s captured within SG&A expenses. A comprehensive view of your finances (both non-operating and operating expenses) is essential to your success and to remain compliant with taxes and regulations. SG&A is also a component subtracted from revenue to arrive at EBITDA.
Consider another core overhead cost: executive salaries. Most companies have at least a CEO, an indirect expense that isn’t relevant to production but is still a necessity for business management and operations. What about marketing expenses? There’s more to business success than production and sales, and understanding your company’s operating expenses can be the bridge to stronger results across the board.
What’s included in SG&A expenses?
Selling, general, and administrative expenses essentially refer to the non-production expenses of a startup and are reported in an income statement (one of your three financial statements) under gross profit. These expenses are not directly attributable to the production of your product. The direct costs associated with producing your product are called the cost of goods sold (COGS) and don’t fall into SG&A expenses.
Using your operating expenses to gauge overall operating income
You can use your SG&A to gain insight into your operating expenses and analyze costs not directly tied to production (like administrative expenses). By calculating your operating expenses as a percentage of total revenue, you can view the percentage of each dollar spent on non-production costs.
To calculate your operating income, subtract your COGS from your sales revenue. The result is your gross profit. Subtract your operating expenses from your gross profit, and your operating income is all that remains. To put it simply:
Sales Revenue - COGS = Gross Profit
Gross Profit - Operating Expenses (including SG&A) = Operating Income
It only makes sense that by cutting down your operating expenses, you can maximize your operating income: let’s take a look at each part of SG&A.
Selling expenses
Your selling costs include different elements, some of which are direct selling expenses and others indirect selling expenses. These direct and indirect costs add up to the total cost of marketing, selling, and distributing your product, such as:
- Sales commissions, transaction costs
- Sales wages, salaries, payroll taxes, and benefits
- Marketing, promotion, and advertising expenses
- Travel, meals, and lodging for staff to sales calls, events like trade shows, and client meetings
- The majority of delivery charges are G&A*
*This depends on the industry. Anything inventory-related will fall under COGS. Delivery accounting can get complicated (ask Macy’s!), so consult with a qualified CPA if you have shipping expenses for physical items.
General expenses
General expenses are incurred by your startup regardless of the industry or the products/services you produce (some considered fixed costs, some semi-variable). General expenses, typically recorded in your income statement, can include:
- Rent for office space that can’t be attributed to your production process
- Utilities, including electricity, water, or sewer expenses, which aren’t part of your manufacturing process
- Office equipment like computers, servers, printers, or telephones that aren’t part of production
- Office supplies that are used for administrative functions
- Insurance
Administrative expenses
Administrative expenses are the costs involved in having administrative personnel, both internal and external if the company outsources any functions. Administrative expenses are also recorded in your income statement, and can include:
- Accounting payroll or fees for outsourcing
- Information technology payroll or fees for outsourcing
- Human resources personnel
- Legal counsel
- Some consulting fees
The key difference between general and administrative expenses
Understanding the different kinds of expenses is key to success. A great place to start is your operating expenses, the price of running your day-to-day operations. General and administrative expenses hold distinct differences, but both qualify as operating expenses.
Neither administrative nor general expenses fall under the production of goods and services. Administrative costs deal with the mechanisms of managing a business while general expenses deal with the price of running a business.
It’s important to recognize that overlap can exist, and depending on how the company classifies these costs, some expenses may fall under both categories.
Is Research and Development included in SG&A?
The short answer? Usually not. Research and Development (R&D) is typically listed as an operating expense (as it is an investment in future production) but rarely qualifies as an SG&A expense because it’s not usually essential to daily operations.
SG&A costs cover a lot of essential functions
There is a great benefit in having a tight and accessible view of your selling, general, and administrative expenses. Managing your selling, general, and administrative expenses is critical for your startup’s profitability, but you should be careful. Cutting SG&A costs can give your profits a quick boost, but that could be at the expense of your long-term profitability. For example:
- Reducing marketing and advertising costs could improve your bottom line in the short term, but you could be losing sales further down the road.
- Not hiring a professional accountant could cost you later if you don’t get the right tax credits, like the R&D tax credit, or if you end up paying fines and penalties because you’re not paying the right taxes in states where you do business.
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Not hiring an attorney to review legal contracts could mean you’re not getting the best deal.
Business strategy, structure, and growth concerning SG&A expenses
If you’re struggling with profitability, there may be something structurally wrong with your business model. You should analyze your income statement as a whole, looking at all the elements of your company — and not focus on a narrow area like operating expenses. It’s easy to slip into a mindset of emphasizing sales, research and development, or product manufacturing and short-change SG&A expenses.
That doesn’t mean it’s correct to overspend on SG&A. You should approach selling, general, and administrative expenses (like marketing costs) as an investment because it can be a competitive advantage. Without these functions, your company may never take off. Invest wisely, and get the right bang for your buck (in both operating expenses and production costs) so you can run your business efficiently and effectively.
As an aside, if you’re trying to get a quick read on your startup’s profitability, you can take your sales revenue, subtract the cost of goods sold, and you’ll get gross profit. Subtract SG&A expenses from gross profit, and you’ll get your operating income. That’s a good process to know, and investors look closely at operating income.
Need a guide? We can help you navigate the startup tax landscape.
We work with companies every day to fix their accounting. If you have any other questions on SG&A expenses, startup investing, startup accounting, or taxes, please contact us. You can also follow the Kruze YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!
