Income Statement Operating Expenses – SG&A and R&D
In the previous small business financial management lessons, we’ve been working our way through the income statement using the Fish Shack as our example (a little roadside food vendor we came across while traveling through Australia). In this lesson, we’ll talk about the different income statement operating expenses. Expenses are found on the income statement after the Gross Margin and before Income From Operations. One of the large groupings for a company’s expenses is Sales, General and Administrative Expenses which is usually abbreviated as SG&A. Another common expense that you’ll see on income statements is Research and Development (R&D). You may hear people talk about “overhead expenses” which generally refer to the total operating expenses the company usually has.
Difference Between Cost of Goods Sold and SG&A
Earlier, we discussed cost of goods sold (COGS) and said that is the costs of making or purchasing the products to be sold later. Cost of goods sold can include wages for people directly making the product, raw materials and any other costs directly associated with making the product. In contrast, expenses like sales, general and administrative expenses include the rest of the charges that it takes to run the business. This can include any marketing efforts, legal fees, paying your accountant, salaries for managers, etc. The general rule for deciding whether to classify something as a cost of goods sold or as expenses is to ask yourself if the material is used in the product you are selling or if the person touched the product in the manufacturing line. If this is true, most of the time it should be a cost and the wage or raw materials can be called a cost of goods sold. If they are not directly used to make the product, it’s probably safe to classify it as an expense such as sales, general and administrative.
Fish Shack Operating Expenses
We’ve already calculated the gross margin for the Fish Shack over the last month which was $17,632.50. Now let’s calculate the total SG&A for the company over the last month. Let’s say that rent for the shack was $3000 per month. We’ll also say that the Fish Shack paid a total of $250 per month to have advertisements on small billboards on the main road. The company also has to pay an accountant $500 per month to manage the finances and has insurance which is $500 per month. While the Shack has a manager working each day, they are actively involved in making the food and are paid $10/hour. Finally, the fish shack has spent a total of $300 this month on trying out new recipes to hopefully expand the menu in the future.
Based on this information, let’s calculate the Fish Shack’s sales, general and administrative expenses. Looking at the values above, we need to add up all the general expenses to calculate the SG&A:
SG&A per Month = $3000(rent) + $250(advertising) + $500(accountant) + $500(insurance) = $4250 per month
Note that we didn’t include the wage of the manager since they were actively involved in making the food. Their wages were included in the costs of goods sold since they are directly tied into making the product. We also left out the $300 per month expenses for trying new recipes since this should be classified as a research and development expense because they are using this information to make new products. Now we’ll add all of these values into the income statement on the left. Finally, we can calculate the total operating expenses by adding together the SG&A and R&D expenses:
Operating Expenses: $4250(SG&A) + $300(R&D) = $4550 per month
Key Takeaway: Income statement operating expenses like SG&A and R&D are charges that the company has to pay for to develop new products or run the business. Costs of goods sold are charges that the company pays to directly make or purchase a product.
All the Operating Expenses on the Income Statement