DAY2 Education : Lower Costs and Expenses Means Better?
Review:
【Investor Education】11 days of Financial Statements Column
DAY1 Education : Sustainable Competitive Advantages Explained
Hey, tigers:
Today is the second day of "Learn US financial reports for beginners ".
In this article, I mainly introduce: Is less cost and expense better for listed companies? three key metrics of ''Operating Expenses'' in the income statement : SG&A expenses, R&D expenses, and depreciation expenses.
By learning these three metrics, we can assess the cost management capability of a company.
1. Selling, general and administrative expenses(SG&A Expenses)
Selling, general and administrative expenses, as its literal meaning, includes selling expenses and administrative expenses.
Selling expenses are the costs of hiring people, advertising and marketing to sell its products; administrative expenses are the costs of corporate management, including travel, hospitality, and salaries, etc.
This concept seems simple, right? But I would remind you here that the ratio of SG&A Expenses/Operating Expenses is very critical, which can have hidden information.
Let me give you an example of Ford in the auto industry.
During the past 5 years, the SG&A Expenses accounted for 54% of total operating expenses, which means that Ford was paying very high costs in this section.
If its product sales are low, investors' money can hardly return. Once the company with high SG&A expenses is trapped in financial crisis, investors are likely to suffer great losses.
So you need to be careful about companies that are stuck with high "SG&A Expenses".
2. Research and development expenses(R&D Expenses)
We all know that technology drives productivity. But is it really better to spend more on research and development no matter what?
Of course not. Technology is changing rapidly nowadays. Excessive R&D expenses not only consume a lot of human and financial resources, but also make a company's operation vulnerable once the company's research is disrupted by other disruptive technologies.
Warren Buffett has a principle when reading financial reports: companies that must spend heavily on R & D are at competitive disadvantage.
Once these technologies become obsolete, the company’s long-term prospects will be in jeopardy. Therefore, investors should be particularly cautious when investing in companies that consistently invest high amounts of investment in R&D.
3. Depreciation and amortization expenses
Depreciation and amortization expenses are usually of great importance in the manufacturing industry. The property, plant, and equipment purchased by a company will eventually be scrapped due to wear and tear.
They are called depreciation and amortization expenses in the income statements.
Suppose your company purchased communication equipment worth USD 200,000 this year. The economic life of the equipment is 10 years.
According to the regulations of the U.S. IRS, the $200,000 expenditure cannot be expensed at one time, but shall be included in the depreciation expenses of each year, i.e. the 10-year schedule.
In other words, the annual depreciation expense is: USD 200,000 / 10 years = USD 20,000 per annum.
Regarding this equipment, the annual depreciation expense is USD20,000, which is amortized year by year. After 10 years, the equipment will be scrapped.
As you see, depreciation and amortization is applied to average out the expense of property, plant, equipment over its economic life.
While there is nothing wrong with this calculation method, many companies are abusing this convention.
For example, some companies will try to extend the depreciation time, in order to create more profit for the current period.
4. Is less cost and expense better for listed companies?
With these three subjects in mind, let's go back to the original question:Is less cost and expense better for listed companies?
Of course not! But why? Because a company reduces employee benefits and wages in order to cut costs, then the company's operation will have problems.
If you were working for this company, you would surely leave. Therefore, excessive cost control might only reduce brand value or lead to high employee turnover.
Increasing revenue and reducing costs are equally important. Both of them are designed to increase income, which determines whether the company is competitive or not.
In other words, we need to be more concerned about how much money a company has left.
we can understand that cost reduction and efficiency increase also need to pay attention to the basic welfare of employees and so on, which can maintain a stable and long-term development of a listed company.
Okay, today's content is over. This is also the key content of our "US Stock Financial Statements for Beginners" lesson 5.
Today's Interaction: Comments Win 20-50 Tiger Coins!
Modify on 2022-09-29 12:21
Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.
"Is lower costs and expenses better?" That is a thought provoking question when analysing a company.
Lesson 2 - Today I learnt that that lower costs and expenses are not necessarily better. While it is important to reduce expenses, it is also critical to look at staff welfare too. I also learnt that SG&A, R&D and Depreciation can also be a subject of misaccounting like Depreciation time span can be extended to make the accounts look good.
There are certainly many implications and nuances when analysing a company.
Thanks @Tiger_Academy for an excellent lesson presented in an informative and interesting manner. I certainly look forward to Lesson 3.