SG&A: Read It as a Share of Sales
SG&A - selling, general and administrative expenses - is the cost of running a company that is not attributable to producing what it sold. Most of the total is fixed in the short term, which is why a fall in revenue produces a larger proportional fall in profit.
How it works
SG&A sits between gross profit and operating income. The costs of making the product are already gone; this line is everything else needed to run the business and sell what it makes.
Three distinct categories share one label. Selling covers sales staff, commissions and marketing. General and administrative covers head office, finance, legal and the rest of the machinery. Only the first has any natural relationship to volume.
The contrast with cost of goods sold is the point. Sell half as much and the cost of goods roughly halves; the head office does not.
Why it drives operating leverage
Most of the line is fixed in the short term. Leases, salaries and systems continue whatever happens to sales, and cutting them takes quarters rather than weeks.
That fixity is operating leverage. In the illustration a 10% fall in revenue produces a 23% fall in operating income, because 900 of overheads did not move while everything above it did.
The same mechanism works upward. A 10% rise in revenue produces a disproportionately larger rise in profit, which is why operationally geared businesses are volatile in both directions and why their earnings are harder to forecast than their sales.
The two halves should behave differently. Selling costs rising with revenue is normal; administrative costs rising with revenue means the business is not gaining any efficiency from being larger.
In practice: read the ratio
The absolute figure is meaningless without the revenue beside it. Overheads as a percentage of sales, tracked across years, is the version that carries information.
A rising ratio on flat revenue is the signal to investigate. Costs growing without sales growing is either an investment that has not paid off yet or a business losing control of itself, and the accounts alone will not say which.
Share-based compensation is inside this line and uses no cash. It is a real cost to shareholders through dilution, and it is the reason a company’s overheads can exceed the cash it actually spent on them.
It is the first line cut under pressure. Marketing and headcount are reducible quickly, which is exactly why cuts here can raise this year’s profit while removing next year’s growth.
Presentation varies between companies. Some report selling, general and administrative separately; some combine everything; some move research spending in or out. Comparing two companies means checking what each one put in the line.
Five years of the ratio is the useful view. One year has no trend in it, and the trend is what distinguishes a business getting more efficient from one that had a good quarter.
One split inside the line is worth reconstructing even though companies rarely publish it: what is growing the business against what is running it. Sales and marketing spending buys future revenue; finance, legal and head office keep the lights on. A company where the first is growing and the second is flat is scaling; one where the second is growing is adding weight.
The segment note and the cash flow statement usually contain enough to estimate the split. Headcount disclosures, marketing spend where it is given, and share-based pay by function all help. Even a rough split changes the reading, because a rising overhead ratio driven entirely by sales investment is a different company from one driven by administration.
And the ratio has a natural floor that varies by business model. A software company will never get its overheads down to a retailer’s percentage, because the cost of acquiring a customer is most of what it spends. Compare a company with its own history first and its industry second — those two comparisons answer different questions, and the cross-industry one answers almost nothing.
What SG&A is not
It is not the cost of the product. That sits above, in cost of goods sold.
It is not all fixed. Selling costs move with volume; the rest largely does not.
It is not comparable across companies without checking. Definitions vary.
And it is not all cash. Share-based pay is inside it.
When it fails as a signal
A rising ratio can be a deliberate investment. A company building a sales force ahead of growth reports exactly the same pattern as one losing cost control, and only the following two years distinguish them.
A second failure is a falling ratio achieved by cutting. Overheads down and revenue flat looks like efficiency for a year and frequently shows up as lost growth afterwards.
A third is comparing across industries. A software company’s overheads are a much larger share of revenue than a retailer’s, and neither figure is wrong.
A fourth is ignoring what moved between lines. Reclassifying a cost from cost of goods to overheads changes gross margin and this ratio simultaneously, with no operational change at all.
And a fifth is reading it without revenue. The number alone says nothing.
The original data
Of the 31,760 trading and investing videos in this site’s corpus, 0 have “income statement” in the title
and 3 have “financial statements” at a median of 1,065,893 views. “Cash flow” returns 17 at a median of
67,134 across 14 channels, and “valuation” returns 9 at a median of 17,868. The counts are in
research/corpus-coverage.json, produced by site/measure_corpus.py.
The figures in the diagrams on this page are illustrative and chosen to make the leverage visible. The 10% revenue fall producing a 23% operating income fall is the arithmetic of 900 in fixed overheads against 1,600 of gross profit, and it is the single most useful thing this line explains.
The habit worth adopting is one division, five times. Overheads over revenue for each of the last five years, written in a row. A ratio drifting upward is the earliest warning most sets of accounts give you, and it appears well before it reaches the profit figure anybody quotes.
Related
Operating expenses is the wider category this belongs to. Operating income is what remains after it. And income statement is the statement it sits inside.
The ratio is the only version of this line I look at. An absolute figure tells me nothing without knowing the size of the business, and the trend in the ratio over five years has told me more about how a company is being run than almost any other single number.
— Michael Whitman
This page is educational, not financial advice. Test every idea on your own charts before risking money.