What Are Administrative Expenses?

Administrative expenses are expenses an organization incurs that are not directly tied to a specific core function such as manufacturing, production, or sales. These overhead expenses are related to the organization as a whole, as opposed to individual departments or business units.

Understanding Administrative Expenses

Administrative expenses may include salaries of senior management and the costs associated with general services or supplies; for example, legal, accounting, clerical work, and information technology. These costs tend not to be directly related to the production of goods or services of a business and are usually excluded from gross margins.

Companies incur administrative expenses in order to perform basic operations (e.g., administer payroll or healthcare benefits), increase oversight and efficiency, and/or comply with laws and regulations. On the income statement, administrative expenses appear below cost of goods sold (COGS) and may be shown as an aggregate with other expenses such as general or selling expenses.

Some administrative expenses are fixed in nature, as they are incurred as part of the foundation of business operations. These expenses would exist regardless of the level of production or sales that occur. Other administrative expenses are semi-variable. For example, a business will always use some minimum level of electricity to keep the lights on. Beyond that point, it can take measures to reduce its electric bill.

Because a business can eliminate administrative expenses without a direct impact on the product it sells or produces, these costs are typically first in line for budget cuts. Management is strongly motivated to maintain low administrative expenses relative to other costs, as this allows a business to utilize leverage more effectively. The sales-to-administrative expense ratio helps companies to measure how much sales revenue is being portioned to covering administrative costs.

Companies can deduct from their tax returns administrative expenses that are reasonable, ordinary, and necessary for business operations. These expenses must be incurred during the usual course of business and deducted in the year they are incurred.

Other Types of Administrative Expenses

Wages and benefits to certain employees, such as accounting and IT staff, are considered administrative expenses. All executive compensation and benefits are considered an administrative expense. Building leases, insurance, subscriptions, utilities, and office supplies may be classified as a general expense or administrative expense.

Depending on the asset being depreciated, depreciation expenses may be classified as a general, administrative, or selling (marketing) expense. Organizations may choose to include consulting and legal fees as an administrative expense as well. However, research and development (R&D) costs are not considered administrative expenses.

To get the full picture of the costs associated with running certain business units, a company may allocate out administrative expenses to each of its departments based on a percentage of revenue, expenses, square footage, or other measures. Internally, this allows management to make decisions about expanding or reducing individual business units.

Example of Administrative Expenses

For example, if XYZ Company spends $4,000 monthly on electricity and records this as an administrative expense, it might allocate the cost according to the square footage each individual department occupies. Assume:

• The production facility is 2,000 square feet
• The manufacturing facility is 1,500 square feet
• The accounting office is 750 square feet
• The sales office is 750 square feet

The company occupies 5,000 square feet. The electric bill could be allocated as follows:

• Production: $1,600 or (2,000 / 5,000) x $4,000
• Manufacturing: $1,200 or (1,500 / 5,000) x $4,000
• Accounting: $600 or (750 / 5,000) x $4,000
• Sales: $600 or (750 / 5,000) x $4,000

What Is an Asset Management Company (AMC)?

An asset management company (AMC) is a firm that invests pooled funds from clients, putting the capital to work through different investments including stocks, bonds, real estate, master limited partnerships, and more. Along with high-net-worth individual (HNWI) portfolios, AMCs manage hedge funds and pension plans, and—to better serve smaller investors—create pooled structures such as mutual funds, index funds, or exchange-traded funds (ETFs), which they can manage in a single centralized portfolio.

AMCs are colloquially referred to as money managers or money management firms. Those that offer public mutual funds or ETFs are also known as investment companies or mutual fund companies. Such businesses include Vanguard Group, Fidelity Investments, T. Rowe Price, and many others.

AMCs are generally distinguished by their assets under management (AUM)—the amount of assets that they manage.

Understanding Asset Management Companies (AMCs)

Because they have a larger pool of resources than the individual investor could access on their own, AMCs provide investors with more diversification and investing options. Buying for so many clients allows AMCs to practice economies of scale, often getting a price discount on their purchases.

Pooling assets and paying out proportional returns also allows investors to avoid the minimum investment requirements often required when purchasing securities on their own, as well as the ability to invest in a larger assortment of securities with a smaller amount of investment funds.

AMC Fees

In most cases, AMCs charge a fee that is calculated as a percentage of the client’s total AUM. This asset management fee is a defined annual percentage that is calculated and paid monthly. For example, if an AMC charges a 1% annual fee, it would charge $100,000 in annual fees to manage a portfolio worth $10 million. However, since portfolio values fluctuate on a daily and monthly basis, the management fee calculated and paid every month will fluctuate monthly as well.

Continuing with the above example, if the $10 million portfolio increases to $12 million in the next year, the AMC will stand to make an additional $20,000 in management fees. Conversely, if the $10 million portfolio declines to $8 million due to a market correction, the AMC’s fee would be reduced by $20,000. Thus, charging fees as a percentage of AUM serves to align the AMC’s interests with that of the client; if the AMC’s clients prosper, so does the AMC, but if the clients’ portfolios make losses, the AMC’s revenues will decline as well.

Most AMCs set a minimum annual fee such as $5,000 or $10,000 in order to focus on clients that have a portfolio size of at least $500,000 or $1 million. In addition, some specialized AMCs such as hedge funds may charge performance fees for generating returns above a set level or that beat a benchmark. The “two and twenty” fee model is standard in the hedge fund industry.

Buy Side

Typically, AMCs are considered buy-side firms. This status means they help their clients make investment decisions based on proprietary in-house research and data analytics, while also using security recommendations from sell-side firms.

Sell-side firms such as investment banks and stockbrokers, in contrast, sell investment services to AMCs and other investors. They perform a great deal of market analysis, looking at trends and creating projections. Their objective is to generate trade orders on which they can charge transaction fees or commissions.

Asset Management Companies (AMCs) vs. Brokerage Houses

Brokerage houses and AMCs overlap in many ways. Along with trading securities and doing analysis, many brokers advise and manage client portfolios, often through a special “private investment” or “wealth management” division or subsidiary. Many also offer proprietary mutual funds. Their brokers may also act as advisors to clients, discussing financial goals, recommending products, and assisting clients in other ways.

In general, though, brokerage houses accept nearly any client, regardless of the amount they have to invest, and these companies have a legal standard to provide “suitable” services. Suitable essentially means that as long as they make their best effort to manage the funds wisely, and in line with their clients’ stated goals, they are not responsible if their clients lose money.

In contrast, most asset management firms are fiduciary firms, held to a higher legal standard. Essentially, fiduciaries must act in the best interest of their clients, avoiding conflicts of interest at all times. If they fail to do so, they face criminal liability. They’re held to this higher standard in large part because money managers usually have discretionary trading powers over accounts. That is, they can buy, sell, and make investment decisions on their authority, without consulting the client first. In contrast, brokers must ask permission before executing trades.

AMCs usually execute their trades through a designated broker. That brokerage also acts as the designated custodian that holds or houses an investor’s account. AMCs also tend to have higher minimum investment thresholds than brokerages do, and they charge fees rather than commissions.

Example of an Asset Management Company (AMC)

As mentioned earlier, purveyors of popular mutual fund families are technically AMCs. Also, many high-profile banks and brokerages have asset management divisions, usually for HNWI or institutions.

There are also private AMCs that are not household names but are quite established in the investment field. One such example is RMB Capital, an independent investment and advisory firm with approximately $10 billion in AUM. Headquartered in Chicago, with 10 other offices around the U.S., and roughly 142 employees, RMB has different divisions, including:

1. RMB Wealth Management for wealthy retail investors
2. RMB Asset Management for institutional investors
3. RMB Retirement Solutions, which handles retirement plans for employers

The firm also has a subsidiary, RMB Funds, that manages six mutual funds.

What Is Asset/Liability Management?

Asset/liability management is the process of managing the use of assets and cash flows to reduce the firm’s risk of loss from not paying a liability on time. Well-managed assets and liabilities increase business profits. The asset/liability management process is typically applied to bank loan portfolios and pension plans. It also involves the economic value of equity.

Understanding Asset/Liability Management

The concept of asset/liability management focuses on the timing of cash flows because company managers must plan for the payment of liabilities. The process must ensure that assets are available to pay debts as they come due and that assets or earnings can be converted into cash. The asset/liability management process applies to different categories of assets on the balance sheet.

[Important: A company can face a mismatch between assets and liabilities because of illiquidity or changes in interest rates; asset/liability management reduces the likelihood of a mismatch.]

Factoring in Defined Benefit Pension Plans

A defined benefit pension plan provides a fixed, pre-established pension benefit for employees upon retirement, and the employer carries the risk that assets invested in the pension plan may not be sufficient to pay all benefits. Companies must forecast the dollar amount of assets available to pay benefits required by a defined benefit plan.

Assume, for example, that a group of employees must receive a total of $1.5 million in pension payments starting in 10 years. The company must estimate a rate of return on the dollars invested in the pension plan and determine how much the firm must contribute each year before the first payments begin in 10 years.

Examples of Interest Rate Risk

Asset/liability management is also used in banking. A bank must pay interest on deposits and also charge a rate of interest on loans. To manage these two variables, bankers track the net interest margin or the difference between the interest paid on deposits and interest earned on loans.

Assume, for example, that a bank earns an average rate of 6% on three-year loans and pays a 4% rate on three-year certificates of deposit. The interest rate margin the bank generates is 6% – 4% = 2%. Since banks are subject to interest rate risk, or the risk that interest rates increase, clients demand higher interest rates on their deposits to keep assets at the bank.

The Asset Coverage Ratio

An important ratio used in managing assets and liabilities is the asset coverage ratio which computes the value of assets available to pay a firm’s debts. The ratio is calculated as follows:


$\begin{aligned} &\text{Asset Coverage Ratio} = \frac{ ( \text{BVTA} – \text{IA} ) – ( \text{CL} – \text{STDO}) }{ \text{Total Debt Outstanding} } \\ &\textbf{where:} \\ &\text{BVTA} = \text{book value of total assets} \\ &\text{IA} = \text{intangible assets} \\ &\text{CL} = \text{current liabilities} \\ &\text{STDO} = \text{short term debt obligations} \\ \end{aligned}$​Asset Coverage Ratio=Total Debt Outstanding(BVTA−IA)−(CL−STDO)​where:BVTA=book value of total assetsIA=intangible assetsCL=current liabilitiesSTDO=short term debt obligations​

Tangible assets, such as equipment and machinery, are stated at their book value, which is the cost of the asset less accumulated depreciation. Intangible assets, such as patents, are subtracted from the formula because these assets are more difficult to value and sell. Debts payable in less than 12 months are considered short-term debt, and those liabilities are also subtracted from the formula.

The coverage ratio computes the assets available to pay debt obligations, although the liquidation value of some assets, such as real estate, may be difficult to calculate. There is no rule of thumb as to what constitutes a good or poor ratio since calculations vary by industry.

Key Takeaways

• Asset/liability management reduces the risk that a company may not meet its obligations in the future.
• The success of bank loan portfolios and pension plans depend on asset/liability management processes.
• Banks track the difference between the interest paid on deposits and interest earned on loans to ensure that they can pay interest on deposits and to determine what a rate of interest to charge on loans.

[Fast Fact: Asset/liability management is a long-term strategy to manage risks. For example, a home-owner must ensure that they have enough money to pay their mortgage each month by managing their income and expenses for the duration of the loan.]

What Is Asset Management?

Asset management is the practice of increasing total wealth over time by acquiring, maintaining, and trading investments that have the potential to grow in value.

Asset management professionals perform this service for others. They may also be called portfolio managers or financial advisors. Many work independently while others work for an investment bank or other financial institution.

Understanding Asset Management

Asset management has a double-barreled goal: increasing value while mitigating risk. That is, the client’s tolerance for risk is the first question to be posed. A retiree living on the income from a portfolio, or a pension fund administrator overseeing retirement funds, is (or should be) risk-averse. A young person, or any adventurous person, might want to dabble in high-risk investments.

Most of us are somewhere in the middle, and asset managers try to identify just where that is for a client.

The asset manager’s role is to determine what investments to make, or avoid, to realize the client’s financial goals within the limits of the client’s risk tolerance. The investments may include stocks, bonds, real estate, commodities, alternative investments, and mutual funds, among the better-known choices.

The asset manager is expected to conduct rigorous research using both macro and microanalytical tools. This includes statistical analysis of prevailing market trends, reviews of corporate financial documents, and anything else that would aid in achieving the stated goal of client asset appreciation.

Types of Asset Managers

There are several different types of asset managers, distinguished by the type of asset and level of service that they provide. Each type of asset manager has a different level of responsibility to the client, so it is important to understand a manager’s obligations before deciding to invest.

Registered Investment Advisers

A registered investment adviser (RIA) is a firm that advises clients on securities trades or even manages their portfolios. RIAs are closely regulated and are required to register with the SEC if they manage more than $100 million in assets.

Investment Broker

A broker is an individual or firm that acts as an intermediary for their clients, buying stocks and securities and providing custody over customer assets. Brokers generally do not have a fiduciary duty to their clients, so it is always important to thoroughly research before buying.

Financial Advisor

A financial advisor is a professional who can recommend investments to their clients, or buy and sell securities on their behalf. Financial advisors may or may not have a fiduciary duty to their clients, so it is always important to ask first. Many financial advisors specialize in a specific area, such as tax law or estate planning.

Robo-Advisor

The most affordable type of investment manager isn’t a person at all. A robo-advisor is a computer algorithm that automatically monitors and rebalances an investor’s portfolio according, selling and buying investments according to programmed goals and risk tolerances. Because there is no person involved, robo-advisors cost much less than a personalized investment service.

How Much Does Asset Management Cost?

Asset managers have a variety of fee structures. The most common model charges a percentage of the assets under management, with the industry average at about 1% for up to $1 million, and lower for larger portfolios. Others may charge a fee for each trade they execute. Some may even receive a commission to upsell securities to their clients.

Because these incentives can work against the client’s interests, it is important to know if your management firm has a fiduciary duty to serve the client’s interests. Otherwise, they may recommend investments or trades that do not serve the client’s interests.

How Asset Management Companies Work

Asset management companies compete to serve the investment needs of high-net-worth individuals and institutions.

Accounts held by financial institutions often include check-writing privileges, credit cards, debit cards, margin loans, and brokerage services.

When individuals deposit money into their accounts, it is typically placed into a money market fund that offers a greater return than a regular savings account. Account-holders can choose between Federal Deposit Insurance Company-backed (FDIC) funds and non-FDIC funds.

The added benefit to account holders is all of their banking and investing needs can be met by the same institution.

These types of accounts have only been possible since the passage of the Gramm-Leach-Bliley Act in 1999, which replaced the Glass-Steagall Act. The Glass-Steagall Act of 1933, passed during the Great Depression, forced a separation between banking and investing services. Now, they have only to maintain a “Chinese wall” between divisions.

Example of an Asset Management Institution

Merrill Lynch offers a Cash Management Account (CMA) to fulfill the needs of clients who wish to pursue banking and investment options with one vehicle, under one roof.

The account gives investors access to a personal financial advisor. This advisor offers advice and a range of investment options that include initial public offerings (IPO) in which Merrill Lynch may participate, as well as foreign currency transactions.

Interest rates for cash deposits are tiered. Deposit accounts can be linked together so that all eligible funds aggregate to receive the appropriate rate. Securities held in the account fall under the protective umbrella of the Securities Investor Protection Corporation (SIPC). SIPC does not shield investor assets from inherent risk but rather protects those assets from the financial failure of the brokerage firm itself.

Along with typical check writing services, the account offers worldwide access to Bank of America automated teller machines (ATM) without transaction fees. Bill payment services, fund transfers, and wire transfers are available. The MyMerrill app allows users to access the account and perform a number of basic functions via a mobile device.

Accounts with more than $250,000 in eligible assets sidestep both the annual $125 fee and the $25 assessment applied to each sub-account held.

Frequently Asked Questions

The Bottom Line

Asset management firms provide the service of buying and selling assets on behalf of their clients. There are many types of asset managers, with some working for family offices and wealthy individuals and others working on behalf of major banks and institutional investors.