You’ll have heard it said, “It takes money to make money”. It’s something of a mantra in the business world. It’s also one of the few things every business owner can agree on. Whatever the industry, no matter the product or service, there’s always a cost to doing business.
Like it or not, we always have to contend with our overhead costs and it doesn’t take much before they balloon out of control. A good fiscal year, or even a strong quarter, and we tend to loosen our grip on the company purse strings and begin spending a bit too freely. But in good times or bad, keeping a tight reign on your overhead costs is critical to your business’ success.
What is Overhead?
Overhead is any and all business expenses that are not directly related to the labor or materials necessary to producing a product or service. Admittedly, that covers a rather large area. It’s sometimes easier to think of your overhead as any indirect cost relating to providing your product or service, such as:
- License and permit fees
- Professional services (accountants, legal counsel, etc.)
- Administrative costs (salaries for employees unconnected with producing a product or service)
How to Calculate Your Overhead
As a small business owner it is important to understand how to accurately calculate your company’s overhead costs. The goal is to find a way to cut the fat and keep your overhead as low as possible. The lower your overhead the more flexibility you have with pricing your product or service, and that gives you the competitive edge you need to carve out a healthy portion of your market.
In order to accurately calculate your company’s overhead you’ll need to start by reviewing all of your expenses. You need to be thorough here, so take your time and look over all of your financial reports. Once you’ve identified all of your expenses go over the list and sort it into two categories – direct expenses and indirect expenses. It will be easier if you think of indirect expenses as any cost incurred that does not directly result in the production of a product or service.
With your expenses sorted, total up your indirect costs for the month. Next, calculate your total sales for the same period. Using these two sums you can figure out your overhead ratio by using the following equation:
(monthly overhead + monthly sales) x 100 = percentage of overhead costs to sales
Ideally, you want an overhead ratio of no more than 35%.
If your overhead ratio exceeds 35%, or if your business is struggling, you’ll want to take steps to reduce your overhead costs. Fortunately, there are some simple things you can do to lower your operating expenses and get that ratio under control.
Renegotiate Your Rent
Rent is typically one of the larger indirect expenses facing independent business owners. This is especially true for smaller enterprises and start-ups struggling to gain traction in a competitive marketplace. If you feel your rent is contributing to higher than acceptable overhead costs you should consider speaking frankly with your landlord.
While most landlords are loath to reduce rents, they also hate to have any of their properties sitting empty. More importantly, good tenants are hard to find and if you have a good relationship with your landlord you may be able to renegotiate your rent and bring your overhead costs down while ensuring that they retain a valuable renter.
Rethink Your Communications Programs
Traditional phone service is a thing of the past. In most cases businesses no longer need to rely on Ma Bell and landlines to service their customers. Depending on the size of your company, the number of employees it supports, and the type of industry you’re in it may be possible to seriously reduce communication costs by opting for an alternative communications program.
Virtual call services and VoIP phone plans have seriously reduced communication costs for small businesses, offering all of the features and services of a traditional phone company without the high costs. You might also consider using turning to Skype or Google Voice to replace your current phone service. These apps allow you and your employees to turn your tablets and smartphones into a virtual business phone network at a fraction of the price you are currently paying.
Review Your Utility Costs and Consumption
Utility costs account for a large part of a business’ monthly expenditures. Electricity, water, and gas…it all adds up pretty quickly. However, there are some easy ways to help cut back on utility costs.
Installing energy efficient LED bulbs in all of your light fixtures can help reduce their energy consumption by as much as 70%. That’s a major reduction that will be reflected in your monthly billing statement. It’s also worth noting that electronics plugged into outlets continue to draw power even when they are turned off. If you want to cut back on energy use, and the subsequent costs, consider plugging all electronics into power strips that can be turned off at the end of the workday. It is a small savings, but one that will add up over time.
Reevaluate Your Travel Expenses
The price of traveling to company meetings and industry trade shows can cause spikes in your monthly overhead costs. Some of this traveling is by necessity, and cannot be eliminated or avoided. However, you can plan those costly trips more effectively. Whenever possible book your trips well in advance and take advantage of any hotel or travel discounts that are available. A little forethought and early planning will definitely pay off.
For those company meetings that do not necessarily demand your physical presence you might consider teleconferencing as a cost cutting alternative to travel. By attending the function virtually you can maintain your presence at the meeting while still managing to rein in your spending.
Hire an Accountant
This tip is less about saving money and more about finding money. While it may sound counterintuitive to hire on extra help when you’re trying to cut overhead costs, bringing in a professional accountant can often save you money over the long term. Tax and accounting professionals are more likely to find valuable deductions that can save you and your business money. While that doesn’t necessarily cut overhead costs, it does provide some much needed financial flexibility.
One Final Tip
Every business owner, regardless of industry or enterprise, has to grapple with his or her overhead costs. It’s the nature of doing business. The trick is to address your overhead costs before they become a problem. Don’t let yourself get seduced by the good times.
When business is good and money is flowing freely it’s all too easy to forget about your overhead costs. But that is the very time you should stop and take measure of your overall expenses. Waiting until you are forced to cut costs is asking for trouble. Be proactive, and reassess your business’ overhead costs today and take the necessary steps to bring them in line with your future plans for success.