How Administrative Expenses Work

Administrative expenses are costs that are not associated with the goods or services the company renders. These costs are not associated with a specific function either. Instead, they refer to the costs of an organization as a whole. However, they are indirectly related to production and sales. You will sometimes hear administrative expenses referred to as operating expenses. Operating expenses are part of an administrative budget that includes selling, general, and administrative (SGA) costs.

While some administrative expenses are fixed, they can also be variable and semi-variable. Organizations will usually try to reduce or eliminate administrative costs since most expenses don't impact their products or services. For example, a business will need a certain amount of utilities to operate, but the total costs can change depending on the month. By focusing on closing lights and using energy-saving products, a business can reduce this cost.

Administrative expenses will exist for all types of businesses, including large corporations, small businesses, start-ups, and nonprofits. To determine your business's administrative expense percentage, you will need the total operating expenses, gross income, and salary expenses. While the percentage will vary for every organization, nonprofits usually set aside 10 percent for administration expenses.

Administrative Expenses Example

Administrative expenses are non-manufacturing expenses. Businesses will place it below the cost of goods sold on their income statement.

Even if you are a manufacturing company, you will have administrative expenses indirectly involved with the production of your products. For example, if you manufacture computer parts, the costs of acquiring offices to manage different administrative departments will be administrative expenses. Additional examples of administrative expenses include:

  • General repairs and maintenance
  • Office maintenance
  • Insurance
  • IT services
  • Utilities
  • Marketing
  • Building rent and maintenance
  • Employee benefits and retirement plans
  • Salaries and wages of employees in departments such as finance, accounts, human resources, and information technology

Significance Of Administrative Expenses

Understanding your organization's administrative costs is important to help you track your finances. You can better understand your operating costs and how much to pay yourself and your employees. A comprehensive financial plan, including administrative costs, can also help attract investors and lenders.

By maintaining low administrative expenses, businesses can also utilize leverage more effectively. Leverage is an investment strategy where a business can use borrowed money to increase its potential return of investment (ROI). To accomplish this, knowing what variable administrative expenses you can reduce is crucial. During budget cuts, managers will usually look at administrative costs to trim first.

Businesss' can also deduct administrative expenses that are necessary, ordinary, and reasonable for operations on their tax returns. The business must deduct the expenses the same year they incur the costs. Administrative expenses also allow businesses to comply with municipal and state laws or regulations. By being compliant, they can avoid receiving administrative charges from enforcement officers.

Administrative Expenses vs. Selling Expenses

While administrative expenses are considered an indirect cost to production, you can't classify all indirect costs as administrative. Selling expenses are costs directly associated with activities generating sales and revenues. Examples of selling expenses include:

  • A sales representative's salary or benefits
  • Commission costs from selling a product or service
  • Travel or accommodations in line with the sale

Selling expenses are generally directly proportional to the number of products or services sold. Implementation and fulfillment of a sale is not a selling expense.