Reducing business overhead costs
Overhead costs: how to calculate them and how to keep them down
Business owners the world over agree that the not-so-secret secret to business success is to keep your costs low. It doesn’t matter how much profit you make, if your revenue is not enough to meet your overheads, you will be operating at a loss and your profits will eventually dry up.
Let’s start with a definition. Finance expert Investopedia defines overhead as "an accounting term that refers to all ongoing business expenses not including or related to direct labor, direct materials or third-party expenses that are billed directly to customers."
So, overheads are the fixed costs of running your business. Whether you manufacture 100 pairs of shoes or 1,000 pairs of shoes, you still have fixed costs to pay. These include things like rent, insurance, utilities, office supplies, vehicle and travel expenses, and advertising.
All businesses have overheads and keeping them low is the key to financial success. Tracking your overheads is not just important for budgeting purposes and cash flow; it also helps you to determine how much you should be charging for your product or service.
How to calculate your overhead costs
It’s useful to calculate your overhead costs on a monthly basis. This provides a great comparison tool to see how you are tracking over time. Sales growth won’t translate to profit if you don’t keep a lid on your overheads.
To calculate your monthly percentage of overhead costs:
1. List all your business expenses (be comprehensive).
2. Categorise them according to whether they are a direct result of producing your goods or service (direct costs). All other costs are indirect costs, or overhead.
3. Add up all the overhead costs, divide by monthly sales and multiply by 100.
A resulting ratio of 14% for example, tells you that you spent $14 in overhead expenses for every $100 of sales. Keep an eye on this ratio - even if sales are spiking, a declining overhead/sales ratio spells trouble and needs your attention.
How to reduce your overhead costs:
• Review your advertising. Don’t spend money on advertising that either isn’t working or can’t be measured.
• Look for low cost advertising methods. For example, use your customers as brand ambassadors or get active on social media and online - it’s effective and inexpensive.
• Is your office or factory space fit for purpose? Could you make do with a smaller space? Would a different location reduce your rent and travel expenses?
• Are your vehicles fit for purpose? Generally, the bigger the car, the higher the running costs.
• Are you making the best use of available technology? It can save you time and money. For example, a video conference could hundreds in travel expenses with the same result.
• Are you still printing? Stop.
• Negotiation with your suppliers. This includes your landlord, your telecommunications and energy company and all the companies you do business with.
• Talk to your accountant. Accountants are in a good position to find deductions you may have missed and may be able to share industry benchmarks so you can see how your business compares.
• Review your insurances.
• Is there a better way to do this? Explore your design, process and resource options for a better more cost effective way.
• Have a look around and ask if you need everything you see. Do you really need all that plant, the extra fridge and work stations, the overseas conference?
Running a tight ship in terms of expenses is the best way to protect your bottom line. You can always trim some fat from your overheads; it’s just a matter of knowing where to look and doing it regularly.
And if you want to take this to the next level, why not have your business sale ready for that day you decide to sell.
Share this article:
- Business finance - borrowing the money
- Reducing business overhead costs
- End of financial year checklist
- Making the most of small business downtime
- Using the bank to arrange business finance
- Cash flow for small business owners
- Spring cleaning your business
- Financing a franchise, what the bank wants
- Financial tips for small business owners
- 3 tax considerations when purchasing a business
- Cashflow forecasts and liquidity
- Left Brain Right Brain, Financial Performance
- Using accounts payable to your advantage
- Cash flow financing or factoring finance
- Cloud commerce for business
- Avoid cyber attacks on your business