Recession speculation has dominated the news cycles over the last few months, with numerous fingers pointing to fallout from the global pandemic, geo-political events, supply chain issues, rising inflation and overall decreases in economic growth, among other things. While that all adds up to a gloomy prospect, it’s important for small business owners to remember that the economy is cyclical, and impossible to predict with absolute certainty.
In short, don’t panic.
Instead, take a proactive look at areas of your business where you can be more conservative without knee-capping your products or services. Regularly examining your overhead is an essential component of keeping your business running efficiently and smoothly, while positively influencing your cash flow. Below, we’ll outline what overhead costs are, how to calculate them and share some creative ideas for reducing them.
First, let’s define the term “overhead expense.”
Essentially, any indirect cost of business that can’t be associated with making a product or performing a service is defined as “overhead.” While “costs of goods sold” (or COGS) are direct expenses that you can tie to a particular service or sale, overhead expenses include all of the costs that allow you to be in business, and they can easily creep up if you’re not paying close attention (kind of like all the entertainment streaming services people forget they have).
Here are some of the most common overhead costs for small businesses:
- Rent or mortgage payments
- Business insurance
- Payroll and employee benefits
- Professional fees (accounting, legal, etc.)
- Website and internet service
- Software licenses and computer equipment
- Telephone service
- Shipping and handling
These are just some examples. Overhead costs will vary from business to business.
Next, let’s look at fixed vs. variable and semi-variable overhead costs.
Some overhead expenses are easier to plan for than others. Fixed costs are expenses that don’t change from billing cycle to billing cycle. Think rent or mortgage payments, insurance and employee salaries. These known costs are easier to budget for throughout the year.
Variable costs are a little trickier, and when it comes to budgeting, usually easier to base a budget on a monthly average of past expenses. Examples of variable costs are things like office supplies, general maintenance and miscellaneous other expenses that your business may regularly purchase or services you might need.
Semi-variable costs are a little more regular in terms of timing, but the full amount may change. Utilities are a good example here, as you have a repeat monthly expense for power, water, etc. but the usage amount will vary. Hourly employee overtime and outside professional fees are other examples of semi-variable costs.
So, is there a good percentage for overhead costs?
The answer to this will vary with the type of business, but a rough estimate for most small businesses is between 10% and 30%. Service businesses like accounting firms, film production companies and web developers typically have lower overhead costs than product-based businesses like manufacturers or retail operations.
The lower the overhead percentage, the higher the profit. Generally, anything over 35% of gross revenues should trigger an alarm bell. Though again, this number depends greatly on the type of business and industry.
How do I calculate my overhead expenses and rate?
Here’s where we go back to the direct vs. indirect costs. As you’re combing through your expenses, anything that cannot be considered a direct cost of goods sold is an indirect cost. These are the ones you want to highlight, analyze and keep in check as much as possible to avoid any unnecessary spending.
When it comes to labor, note that there are direct and indirect costs. If you hire a subcontractor to work on a specific project, that labor cost is directly tied to a product or service and should be passed on to the customer through your pricing. Alternatively, full-time employees like administrative assistants and salespeople are indirect costs and thus, overhead.
Once you’ve found and tallied up your indirect costs, you can determine your monthly total or average monthly total. You can use this ratio to calculate your overhead percentage rate:
(Monthly Overhead ÷ Monthly Sales) x 100 = Percentage of Overhead Costs to Sales
So, you know your overhead. Now let’s find ways to decrease it.
Every little bit helps, especially when added up over time. Here are a few ideas for bringing down those overhead costs:
- Start with that hard review of your expenses to see what is unnecessary. This could include things like:
- Canceling unused subscriptions or memberships
- Negotiating lower prices with vendors, even if temporarily
- Reducing your marketing budget
- Renegotiating your lease
- Telecommuting or using a co-working space to save on office rent
- Increase your prices. If your costs are going up, you may need to increase your prices to stay profitable. Be sure to do your research to make sure you’re not overreaching in your market. You can gently let your customers know that a small price increase is necessary due to rising supply or fuel costs, etc.
- Reevaluate your office supply needs. Know the difference between “nice-to-have” and “need-to-have” and be practical about it. Evaluate the resources in your office and determine what you truly need to function on a daily basis. (Do you really need to fully stock the snack shelf?) Try a temporary cutback and see what’s actually missed. You may be surprised.
- Automate tasks. A number of tasks can be automated, saving you time and money. For example, you could automate your billing, customer service, or marketing efforts – freeing up your time for more lucrative, revenue-building tasks.
- Outsource tasks. Outsourcing tasks is another way to save time and money. Things like bookkeeping, marketing, or customer service are commonly outsourced.
- Hire freelancers or part-time employees. If the cost of full-time employees isn’t justified by your revenues, consider shifting your strategy to hiring freelancers or part-time employees to save money on benefits and other costs.
- Take advantage of government programs. There are a number of government programs that can help certain small businesses with things like tax breaks, loans, and grants. Be sure to do your research to see if you qualify for any of these programs.
- Network with other small businesses. Networking with other small businesses can open up savings through shared resources, project collaboration, customer referrals, and more. Make relationships with supporting vendors who can pass business your way, or get friendly with similar businesses who may pass along their overflow to you.
- Stay positive and don’t give up. Don’t let the fear of a recession control your business decisions. Being proactive now and working on reducing your overhead will give you back a feeling of control and help you better protect your business if the economy worsens. And if the economic outlook improves or stays the same, you’ll be that much more profitable.
LendThrive can help you cover overhead costs.
If you’ve cut as much as you can but your overhead is still higher than you’d like, LendThrive can help with a fixed-rate business loan. You could qualify for up to $150,000 and be approved in as little as 24 hours.
Apply today or contact us for more information!