The Core of Business Operational Costs: Administrative Expenses
Administrative expenses represent costs a company incurs that are essential but not directly linked to a specific core function, such as production or sales. These overhead expenses are necessary for the overall operation and functioning of a business.
Key Takeaways
- Administrative expenses include costs needed for business support but unrelated to direct production or sales.
- Businesses will always incur some administrative costs for their operations.
- Typically, these expenses are the first to be considered for budget cuts as they do not impact core business activities.
- Companies often allocate administrative expenses proportionately to their various business units based on revenue or other metrics.
Getting to Grips With Administrative Expenses
Administrative expenses encompass salaries for key personnel, general services, or supplies expenses such as legal fees, accounting, clerical work, and IT services. Unlike costs tied directly to product creation, these are commonly excluded from gross margins.
These expenses help businesses maintain basic operations, enhance efficiency and oversight, and ensure legal compliance. On the income statement, such expenses usually appear below the ‘Cost of Goods Sold’ (COGS) category and may be combined with other types like general or selling expenses.
Administrative costs can be fixed—existing regardless of production levels—or semi-variable. For instance, there is always a baseline level of electricity usage for maintaining basic operations, but further action can help to cut down subsequent costs.
Due to their indirect relationship with the product line, businesses often aim to minimize administrative costs to enhance overall leverage. Reducing administrative expenses makes more funds available for focusing on core functions and growth strategies. Notably, certain administrative costs, viewed as reasonable and requisite for business operations, can be deducted in tax filings during the year they are accrued.
Expansion on Types of Administrative Expenses
Wages and benefits for employees like accountants, IT staff, and executives fall under administrative expenses. These may also include building leases, insurance premiums, utilities, and office supplies. Depending on the pertinent asset, depreciation costs may be housed under administrative, general, or selling expenses. Consultancy and legal fees sometimes also fall into this bucket, while Research & Development (R&D) typically does not.
Companies sometimes allocate administrative expenses to business units using formulas based on revenue, expense, or square footage metrics, enabling clear cost tracking for decisions regarding business unit scaling.
Practical Example: Allocation of Administrative Expenses
To illustrate, let’s say XYZ Company incurs a monthly electricity cost of $4,000 classified as an administrative expense. By examining the floor space of its departments—
- Production Facility: 2,000 sq. ft.
- Manufacturing Facility: 1,500 sq. ft.
- Accounting Office: 750 sq. ft.
- Sales Office: 750 sq. ft.
With a total occupied space of 5,000 sq. ft., the allocation may be divvied up as follows:
- Production: $1,600 [(2,000/5,000) * $4,000]
- Manufacturing: $1,200 [(1,500/5,000) * $4,000]
- Accounting: $600 [(750/5,000) * $4,000]
- Sales: $600 [(750/5,000) * $4,000]
Understanding and managing administrative expenses is crucial for ensuring that an organization runs efficiently and maintains robust financial health.
Related Terms: overhead expenses, gross margins, income statement, cost of goods sold (COGS), fixed costs, semi-variable costs, leverage.
References
- Internal Revenue Service. “Deducting Business Expenses”.
