# Sales to Administrative Expense Ratio

## Definition

The sales to administrative expense ratio is an asset utilization measure that allows analysts to understand the level of overhead costs required to support a given level of revenues.  Investor-analysts oftentimes track this ratio over time, since the ratio should decrease as a company achieves economies of scale.

### Calculation

Sales to Administrative Expense Ratio = Net Sales / General and Administrative Expenses

Where:

• Net Sales = Gross Sales - Returns
• General and Administrative Expense: includes those costs that support the daily operations of a company, including legal, human resources, accounting, office supplies, advertising and marketing, payroll, rents, utilities, as well as executive salaries.

### Explanation

Asset utilization measures allow investor-analysts to understand how well a company uses its assets in operations.  The term "assets" refers to human capital when examining the sales to administrative expense ratio.  This metric is typically tracked over time, since it measures the amount of overhead expenses associated with a given level of sales.  Companies with ratios that are lower than their industry average, or have ratios that decrease as sales volume increases, are desirable.

Generally, the investor-analyst will want to see companies exhibit the following patterns in this metric:

• Increasing Sales:  as sales increase and companies achieve greater economies of scale with respect to administrative support functions, the ratio should decrease.
• Decreasing Sales:  as sales decrease, companies need to ensure their overhead expenses can be scaled back too, or these expenses will quickly erode the company's profit margins.

Companies in industries that require a lot of back office support per sale will have higher ratios.  For example, if the average customer invoice is relatively small, it will require more back office support to issue invoices, process payments and collect outstanding receivables.  In the same way, companies with high employee turnover rates will require more human resources support to process and hire replacement employees.

### Example

Company A has entered into discussions with Company XYZ, who was interested in purchasing a division of their business.  While Company A's management team was actively looking to find a buyer for this business, the team was also concerned about the impact it would have on their sales to administrative expense ratio, since these services are centralized.

The business segment to be sold to Company XYZ accounted for 15% of Company A's net sales. The following table illustrates the impact the sale of the division would have on this ratio:

 Existing Operations Post-Transaction Net Sales \$25,500,000 \$21,675,000 General and Administrative Expense \$2,805,000 \$2,805,000 Sales to Administrative Expense Ratio 1:0.11 1:0.13

In order to keep the ratio the same after the sale of the division to Company XYZ (Post-Transaction), Company A would have to reduce their general and administrative expenses by 15%, or \$420,750.