Business scenario: Managing your overhead costs

Managing your overhead costs can make or break your business. If your fixed costs are too high, you may struggle to make a profit, or find yourself scrambling to make payroll during a slow season. If your fixed costs are low, it’s much easier to ride out a downturn.

So what is overhead, and how do you reduce your overhead costs? Basically, overhead costs are the costs of running your business even if you don’t make any product. Your overhead includes rent, utilities, salaries, insurance, advertising, and any other costs that you have to pay before a single customer walks through your doors. Overhead does not include the cost of raw materials or ingredients that go into your product.

Calculating your overhead costs

The first step to managing overhead is, of course, understanding what your current costs are. If you have a year’s worth of actual expenses to review, start there. Add up the total amount you spent on costs like rent, taxes and licensing fees, advertising, and equipment repair. If you own a building, vehicles, or equipment, include the amount of depreciation you’ve claimed as a business expense on your tax return. Don’t forget extras like cleaning supplies or printer paper that aren’t part of making your product.

If you’re starting a new business and you don’t have your own historical data to use, you can look at public company records to see what typical overhead expenses are in your industry. As you do more research about what your rent, insurance, and other expenses will be, you can refine your calculations.

Overhead as a percentage of sales

Once you know your overhead, you can determine how reasonable those costs are. Most companies look at monthly overhead costs as a percentage of monthly sales, but you can also calculate what your overhead costs per week or even per hour are. The key is to see how your overhead relates to your revenue—basically, you want to see how much of what you’re earning is going to the basic costs of running your business.

Typical overhead ratios will vary significantly from industry to industry. For restaurants, for example, overhead should be about 35% of sales. In retail, typical overhead ratios are more like 20-25%, while professional services firms may have overhead costs as high as 50% of sales. For a new business, comparative data can help you see what to expect as you build your business, and can provide a reality check if you’re worried that you’re overpaying for a specific expense.

Reducing overhead

If your overhead ratio is high for your industry or your area, you’ll want to look for ways to reduce those fixed costs. Reducing overhead is particularly important in a downturn or a slow season when revenue is low, because these are the bills you have to pay even if you’re not making any money. Of course, you’ll be better off if you can cut costs before you really need to. Keeping your business lean will boost your profits and ensure you’re prepared for good times and bad.

Here are some tips for reducing common overhead costs:

• Rent: Can you renegotiate your lease? If you can’t get a rent reduction, see if you can get your landlord to foot the bill for repairs. Fixing drafty windows, for example, could cut your utility bills.
• Colocation: Can your business share space with a complementary business? For example, some restaurants rent out their kitchens to catering businesses during off-hours. A retailer might host a pop-up ice cream shop during the summer to draw in foot traffic.
• Utilities: Going green can save you money.
• Insurance: You should reevaluate your insurance policies every year. You may be able to save money by buying several policies from the same carrier, or installing some simple safety features.
• Marketing: Make sure you’re stretching your marketing dollars as far as you can and taking advantage of free promotional opportunities. Word-of-mouth marketing can be a highly effective—and inexpensive—way to promote your business.
• Staffing: Look for ways to reduce your staffing costs without actually cutting staff. Make sure you’re scheduling your staff efficiently based on your slow and busy hours.

Get financing in a pinch

If your revenue has dropped suddenly, or you’re experiencing an unexpected slow season, cutting your expenses will help in the long term, but you may also need short-term financing. Consider some fast-cash options like Rapid Deposit, which can get you cash in a day for a simple 1% fee, or Clover Capital, which can give you a cash advance on future credit card sales, so you’re not stuck with a loan you can’t repay.

Editorial Team

Biz ops, Money management, Run your business, Strategy

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