Fifty Shades of SG&A

 

50-shadesIt’s time that companies become more intimate with their SG&A expense.

At least, that is the topic of an article published in a recent issue of Women’s Wear Daily. The headline “Higher SG&A Costs Hitting Retailers” highlights a current trend in a number of high profile retail companies where SG&A costs as a percent of sales or revenue are increasing when compared to the prior year.

A Word Of Explanation …

Before we go any further, a word of explanation. SG&A expense is a frequently referred to acronym that is short for Selling, General and Administrative expense. SG&A expenses generally refer to expenses such as non-direct or overhead payroll, benefits, commission, marketing, rent, insurance and utilities.

SG&A expenses are generally deemed to be controllable expenses and can be adjusted based on the operations of the business and the level of sales. Because expense dollars vary based on the size of the business and level of sales, many investors and bankers evaluate expenses based on a ratio of SG&A expenses to revenue.

Expenses As A Percent Of Sales …

Or in other words, expenses as a percent of sales. When compared to prior years, the SG&A expense percent to sales ratio should be stable, or in growing businesses, the ratio should be declining.

“If the percent-to-sales-ratio is increasing, it sends up a huge red flag.”

Particularly since investors and bankers use this measure as a way to evaluate how companies effectively utilize their cash.

33 Retailers Were Analyzed …

Of the 33 retailers analyzed, 18, or over half, posted higher SG&A to sales ratios for the most recent quarter, compared to the previous year. Nine of those companies posted more than a 100 basis point increase in this ratio, which is a significant problem. There were two Pacific Northwest companies included in the group of retail companies that were analyzed, namely Nordstrom and Zumiez. Interestingly enough, each company was at opposite ends of the SG&A spectrum.

NordstromNordstrom, whose sales topped $13.5 billion last year came in close to the bottom of the rankings with a 172 basis point increase in their SG&A expense ratio. This is an extraordinarily large increase and definitely negatively impacted their profitability for the quarter.

Zumiez, whose sales were in excess of $800 million last year ranked very high with a reduction of 143 basis points and was the second best performer on the list. Abercrombie and Fitch, a company that has been in the news lately, ranked at the bottom of the list with a whopping 50.5 percent SG&A expense to sales ratio that increased 240 basis points over last year!

Management’s Ability To Utilize Cash …

In our practice, we frequently work with companies that have incurred increasing expense to sale ratios often combined with decreasing sales. Given that the SG&A ratio, as a percent of sales, is a measure that assesses management’s ability to effectively utilize cash, it is a leading edge indicator that should be monitored regularly.

An increasing SG&A percent could be a result of declining sales, or a significant increase in expenses that are incurred in anticipation of increased sales. When addressing this issue, we sometimes hear that expenses cannot be reduced because they have been cut to the bone. Although a pattern of increasing expenses ratios can jeopardize the company’s ability to survive, management sometimes resists further cuts because of some emotional barrier.

The True Fact Is …

The true fact is that expenses must be reduced, when necessary, to ensure the company can continue to be viable. This is particularly important with small to middle market companies that are privately owned. In most cases, the owners personally guarantee the company’s bank line of credit. If the company fails, not only does the owner lose their equity in the business, their personal assets are at risk as well.

The best and most proactive way to monitor the SG&A ratio is during the company’s budgeting process. Typically, budgets are prepared based on assumptions compiled by management including additions to staff, increase in marketing budgets, additional travel plans along with other “wish list” items.

A Reflection Of Assumptions …

Given the budget is a reflection of these assumptions along with the anticipated sales increase; it is relatively easy to compile actual quarterly expense to sales ratios. If ratios are increasing over the prior year, then it is important to go back to the drawing board and address expenses that have increased or must be adjusted for decreases in revenue.

Additional expenses should be prioritized for effectiveness and the budget should be reduced to reflect an SG&A level that shows progress in controlling expenses and supports an improving bottom line. Finally expense to sales ratios must by monitored quarterly and action must be taken to bring them back in line, if they have increased over the planned level.

50 Shades Of …

It is incumbent on every business owner, regardless of whether they are the Nordstroms of the world, or a small family business, to carefully plan and monitor their companies SG&A expense. Doing so will ensure that your company does not end up on the financial spectrum of fifty shades of RED!

And remember, don’t be afraid to ask for help in addressing these issues. Catching the problem early in the cycle will go a long way in addressing your company’s bottom line performance.