The overhead expenses for every business are paid out of the Gross Profit earned. Overhead is either helping the business be more efficient and thus make more money, or it is a drain on the operating profits of the business.
A high SG&A Expense Productivity Ratio indicates that overhead investment contributes to business success. A ratio below one confirms you are overspending on overhead, and it is robbing you of profits.
Any SG&A, also known as an overhead expense, can impact profits since no dollar spent on SG&A is directly attributable to a sale contributing to Gross Profit earnings. To calculate the Throughput Ratio for SG&A Expense Productivity, divide operating profit as the ending output for a period by the total SG&A costs incurred for that input in that same period.
The smaller the ratio, the less impactful your overhead spend is on your Operating Income. The higher the ratio, the more important it is to manage these overhead expenses if you are to make a profit. A negative ratio indicates that this area drains your ability to produce a profit.
The formula for calculating SG&A Expense Productivity is as follows:
Output (Operating Income) / Input (SG&A Expense)
A ratio of -1 means that the company is generating a $1.00 operating loss for every dollar invested in overhead expense. A 2.0 ratio means that $2.00 in operating profit is generated for the equivalent of every $1.00 spent on SG&A.
Higher Creates Opportunity: an increasing ratio indicates that this investment contributes to your business’s success.
Lower Creates Challenges: a ratio significantly below 1 indicates an insignificant contributor in producing operating profit.
Fail to manage your overhead in relation to your ability to pay for it out of Gross Profit and you will make less money 100% of the time.