How to manage overhead costs as a small business
Helping small business owners manage cash flow by reviewing overhead expenses
A common saying in business is that “to make money, you have to spend money.” A lot of this is true; business owners invest money so that they can deliver a product or service to their target market. Costs that are directly tied to the creation of a product or service are considered direct costs. Of course, many other costs go into running a business. One of the most important to look at is indirect costs, more commonly referred to as overhead costs.
Overhead costs are a normal part of business expenses and operations; however, your bottom line can be directly impacted if you don’t have a good sense of what those numbers are. This article will outline the different types of overhead costs and how business owners can calculate their rate of overhead expenses. Moreover, this article will make some recommendations to help business owners track, manage, and reduce overhead costs when necessary.
What are overhead costs?
Overhead costs can be defined as costs that are associated with the day-to-day aspects of running your business. Typically, these costs don’t originate with the product or service themselves nor lead to revenue generation. However, they are usually essential to have so that you can run your business in the first place.
Business overhead costs frequently include office space, office equipment, and office supplies. These costs are especially notable for startup companies that are just getting off the ground. Other common overhead costs include electricity bills, internet, software programs (like accounting software), marketing costs (like social media campaigns or advertising materials), insurance policies, loan interest, partner or vendor costs (lawyers, accountants, etc.), business licensing costs, and payroll costs.
Overhead costs are typically understood by category. The three categories most often used are fixed costs, variable costs, and semi-variable costs.
Fixed costs: Fixed overhead costs are the types of expenses that are consistent and regular over time, meaning that they will be the same every month. For example, if you have business insurance policies, these will typically charge the same fee (monthly or annually). You can expect what these charges are and build this into your overall business budget fairly smoothly. Other fixed expenses include payroll costs (especially for salaried employees), any business subscriptions that you maintain, rent or mortgage payments, or utilities at your business.
Variable costs: Variable costs fluctuate depending on your type of business and can go up or down each month. For example, if you operate a swimming pool, you know that you will incur higher expenses for cleaning supplies during the summer when your business is busier. Alternatively, if your business has more shipping or marketing costs at particular times of the year, this may lead to variable costs that you can’t necessarily predict.
Semi-variable costs: Semi-variable costs are similar to variable costs. However, the primary difference is that semi-variable costs are always present. You can expect this to be an expense for your business, you just don’t always know what the overall cost or rate will be depending on the status of your business activity. For example, if you have a business where you have employees that travel, you know they will use gasoline on a regular basis. But, if they travel more or gas prices increase, the overall cost may be hard to predict. Other examples of semi-variable overhead costs are hourly wages with overtime, commissions, or incentives.
How do you calculate overhead costs?
Maintaining a formula or calculation to monitor overhead costs will help your business long-term. To calculate your overhead rate at your business, you can do the following:
- Calculate all business expenses. Tracking all types of expenses (operating or overhead costs) will help you have a broader view of your cash flow. Understanding all expenses your business incurs will be important to capture so that you can include this in future financial statements. Gathering all expenses can also help reference the business plan, ensuring that you are focusing on your product the way you initially outlined in the beginning stages of your company.
- Categorize all expenses. Once you have a sense of all the expenses and business needs that your business has, you can allocate the expense as either a direct or indirect cost. Categorize your business expenses as direct or indirect. Direct costs are essential for the goods or services produced and will be categorized differently. As discussed, indirect costs are considered part of your overhead.
- Sum up all overhead expenses. Remove your direct costs and direct expenses and add up all overhead expenses that your business maintains.
- Calculate your overhead rate. To capture your business’ overhead rate, you can take your monthly overhead costs and divide this by your monthly sales. Once this is done, you can multiply this by 100 to get a percentage of overhead costs as part of your entire business revenue. Bookkeeping support and accounting teams can help small business leaders calculate this figure automatically and track it over days, weeks, and months so that business leaders are aware of financial trends at their place of business. Having this figure will help initiate ways to introduce cost-saving measures in the workplace and overall operations.
Ways to reduce overhead costs
Reducing overhead can help your business’ bottom line and ensure that your profit margins stabilize and grow over a period of time. Below are some of the best ways that you can begin to reduce overhead costs at your business.
- Track daily and one-off expenses. To get a big picture of your business’ financial situation, you need to see what expenses take place daily. Begin tracking expenses and categorizing the costs daily. You may see some patterns of costs that could be adjusted (for example, considering a different time of the month to pay for certain services) that might help your bottom line.
- Analyze sales. As a business owner, you should not only look at your overhead expenses to reduce overhead costs but also look at sales. Is part of your overhead contributing to a high volume of sales? If so, it may be worth keeping. You can also have a sense of how payroll and labor costs directly impact the success of your business product and if there are times you can reduce your staff hours for a cost-savings measure.
- Track and analyze labor costs. You can consider introducing a POS system for employees to clock in and out. This will help you see how much time employees are working, how much this is costing you, and how this impacts the delivery of your product or service. Moreover, if you have a POS system that is capturing this data, you can compute real-time analytics that will help you see labor trends and inventory management tools over weeks, months, and years.
- Regularly evaluate business contracts. Businesses maintain high levels of partnerships, vendors, suppliers, software systems, subscriptions, and more that contribute to the overall operation of the business. Scheduling a regular time to look at these costs and consider what is necessary for your business plan is important to do. This will help to make sure that every vendor is essential. Moreover, you can also consider renegotiating contracts to get a better rate, particularly if you have been a consistent business partner for a long time.
- Lease equipment. Renting equipment allows your business to upgrade more easily and not have to oversee repair or maintenance costs for costly equipment. Moreover, you can even consider going paperless, which would require less printing equipment that you need in your office, too.
- Market to current customer base. Word of mouth — especially with social media — is a great way to market your business with less financial investment. Encourage customers to complete online reviews and surveys to showcase ongoing customer loyalty and satisfaction. If you focus on building your brand with current customers, they will be able to share their experiences with others.
Are you ready to reduce total overhead costs at your small business? Are you ready to create an income statement that showcases higher profit margins?
Heartland is ready to help.
Heartland helps nearly 1,000,000 entrepreneurs make and move money, manage employees and engage customers with human-centered technology solutions that allow them to rise above the daily grind and lead their businesses into a brighter future. Learn more at heartland.us