Tips For Small Business Owners to Manage Business Overhead Cost

Businesses often go overboard spending in the early stages, hoping to give the best services or products. They don’t realize they could spell financial trouble if their fixed overhead costs are high. Taking control of your overhead costs right from the start could help you save some serious money that could be used more effectively for growth opportunities.

What are Overhead Costs?

Overhead costs are the day-to-day costs incurred for running your business smoothly, such as utility bills, stationery expenses, rent, insurance, etc. They have no direct link to the actual production process or delivery of any services. But without them, you couldn’t operate your business at all.

Let’s simplify: the money you spend buying raw materials or machinery for making your product is called operating expenses. These expenses have a direct link to the profit your business generates. The more you produce and sell, the greater your chance of making a profit.

On the other hand, even if you don’t produce or sell a single product all month, you still have to pay the rent and utility bills for the factory and even your employees’ salaries. Such compulsory expenses are called overhead costs.

But how can one reduce such unavoidable costs? First, we need to understand the various types of overhead costs.

Types of Overhead Costs 

There are three types of overhead costs in every business, no matter how big or small:

Fixed Overhead Costs

These expenses are usually pre-determined and don’t fluctuate, irrespective of how much your business earns. They include rent, taxes or government fees, insurance premiums, mortgages, etc. 

Variable Overhead Costs

These expenses are linked to your business sales and change depending on your business’s performance. They include the cost of office supplies, marketing expenses, shipping costs, legal costs, etc. The more business you do, the higher the variable costs will be, and vice versa. For instance, higher production will lead to higher energy consumption and electricity bills.

Semi-variable Overhead Costs

These costs are unavoidable (hence fixed) but change according to the pace and level of your business activity (and are variable, too). For instance, while you may have a fixed internet subscription plan, the actual cost may vary if the usage is above the subscribed limit. Some of these are also subject to external changes, such as an increase in fuel or power charges. Other examples of semi-variable costs are wages, telephone bills, vehicle expenses, etc.

Calculating Overhead Costs

To know how much you need to save, you first need to know how much you spend. For this, you must identify all the overhead costs your small business incurs, including rent, utility bills, salaries or wages, etc. Having identified them all, collect past bills and study your monthly and annual spending. 

Now, divide this overhead cost figure by total sales or production figures to arrive at overhead cost as a percentage of every unit sold. For example, your overhead cost figure is $30,000, and your production cost is $100,000. It means for every dollar you spent on production, 30% — 30 cents – was just overheads. It is important to remember that the definition of a ‘healthy’ overhead ratio differs from business to business. Restaurants have higher overhead ratios (around 35%) than retail businesses (20-25%). If your small retail business has an overhead ratio of 50%, you need to fix it immediately.

Why is it important to know this? The higher the overhead expenses, the higher the price of the product or service. So, managing overhead costs is crucial to keeping prices competitive and ensuring your business stays in the market race.

Ways to Manage Overhead Costs

There are some simple processes you could put into action right away to make sure your overhead costs don’t go over the top.

1. Using technology: Many business-related tasks such as bookkeeping, calculations, simple accountancy, and invoicing can be automated using some free software. Using such technological tools can help streamline your processes, reducing the cost of hiring extra employees for such basic tasks.

2. Outsourcing: Downsizing and cutting down your staff is a painful experience, both for the staff and the business. But having too many employees means handing out a significant sum of money in salaries and insurance. Instead, you could try working with freelancers or contract staff. For non-core business activities such as auditing, bookkeeping, or even marketing, you can outsource the job to specialists for your convenience, as and when required. 

3. Going green: Are your electricity bills too high? Why not go solar power? Not only will you save some big bucks, but you will also play a part in protecting the environment. You can do much more, like going paperless to save trees, sharing just one company vehicle for business purposes to reduce your carbon footprint, using energy-efficient appliances (including the coffee machine), etc.

4. Save space: The more extensive your office space, the higher the overhead costs. To cut down on this, you could try adopting a hybrid or remote work system with some employees being allowed to work from home. That way, you can probably shift to a smaller space and save considerable money. Or, if you are a service-based business, you could even think of having a virtual office instead of a physical one. Shared office spaces are also a great way to reduce rental costs.

5. Negotiating with vendors: Negotiations are a big part of business. Try working out a better deal or even better payment terms, or negotiate for discounts with your suppliers and third-party service providers. 

6. Regularly monitor your expenses: Are you using all your resources to their optimum capacity? What have you not used in a while? Do you need all that branded stationery? Conducting a regular, honest review of your overhead cost categories gives you scope to reduce spending. 

Consulting an expert to ensure you file for any deductions your business might be eligible for can make a big difference. The same goes for insurance. Take the help of a reliable, trusted expert and review your insurance plans to see if you are over-insured or paying for a plan you don’t need. 

Managing overhead costs can bring long-term efficiency and be a saviour in a downturn.  

Contact KSSP Partners LLP in Markham for Your Business Consulting Needs

A professional business consultant can help you review your operations and develop creative ways to cut costs and improve financial efficiency. To learn more about how KSSP Partners LLP in Markham can provide you with the best business consulting expertise, contact us online or by telephone at 289-554-5997.