All business owners, regardless of their size, should keep close track of any spending related to production. It's a crucial requirement to keep your business afloat. Since they are still in their startup mode, some small businesses don't keep track of their company overhead costs--and that's a huge mistake.
All businesses have an overhead cost. You might be working alone or have hundreds of staff, overhead costs are something that your business has. Learn what overhead costs are, the different types of overhead costs, and how to keep them to a minimum to benefit your business.
What are Overhead Cost?
Overhead costs is costs or expenses you spend to run your business. Overhead costs may not be directly related to a specific product or service you offer and do not generate profit. Although overhead costs don't generate profit, they are still essential to your business and should be accounted for properly.
To further understand overhead costs, it's essential to know the two (2) types of costs:
1. Direct cost. These are expenses your business pays for that are directly related to the production of the goods and services your business offers. Some examples of direct costs include labor and materials.
2. Indirect cost. On the other hand, indirect costs are expenses that your business collects that are not directly related to production costs but are still pivotal to running your business. An example of indirect cost are rentals, internet, etc.
Types of Overhead Cost for Small Businesses
Three (3) types of overhead costs can, directly and indirectly, affect your business:
1. Fixed Cost
2. Variable Cost
3. Semi-variable Cost
The first two types of overhead costs are easy to track and calculate. On the other hand, the last one can be a bit tricky, but it's something that your small business may incur as well. Let's delve deeper into these types of overhead costs.
1. Fixed Costs
As the name suggests, fixed costs are called "fixed" because they are the same amount every month or year. Whether your production activity increases or decreases, fixed costs aren't affected. Here are some fixed overhead cost examples:
- Property taxes
- Building rent
- Mortgage payments
- Administrative salaries of your employees
Suppose you own a small business selling handmade crochet items. You currently rent a small space that houses your administrative staff, production (crocheters) staff, storage, and display.
The lease that you pay for your space is $2,000.00 per month. Last month, you sold a total of $5,500.00 in crocheted items. However, 2 of your crocheters filed for a vacation leave this month which reduced your production, and you only earned a total of $42,800.00.
Even if your output decreased this month, your lease remains at $2,000.00. It's a fixed overhead cost.
2. Variable Costs
On the other end of the cost spectrum, you have variable costs. These are costs that you incur that vary every month or year. Here are some examples of variable company overhead costs:
- Advertising costs
- Cost of materials
- Office supplies
Going back to your crochet business, you incur shipping costs if you sell your crochet items online. These shipping costs depend on how many items you sell and ship, and whether your customers opt for priority shipping (obviously, this would cost more). This cost is variable.
You'll spend more on social media advertising if you also boost your audience engagement this month (compared to last month) because it's your company's anniversary. This type of overhead cost is also variable.
It's also important to note that you might not have variable monthly costs. Again, it all depends on how your business operates.
3. Semi-Variable Cost
Semi-variable costs (or mixed cost) increase when sales and production increases and falls when sales and production fall. You have to note, though, that the up and down can be a different percentage.
Let's say that during your anniversary month, you decided to offer a sale. You received a lot of orders, and to keep up with the demand, you hired an additional work force. The salary for the additional workforce you hired is considered a semi-variable cost.
Importance of Understanding Overhead Costs for Small Businesses
Any money that comes in and out of your business directly impacts your balance sheet and income statement. Overhead costs, regardless of type, and if accounted for properly, can result in accurate product pricing and increased profit.
If you don't include your overhead costs in your product price, you may lose profit because you're pricing your product or service too low. Conversely, if you incorrectly estimate your overhead costs, you might overprice your products. This can lead to slow inventory movement or reduced sales.
Obviously, fully understanding and knowing your overhead cost lets you be more proactive in managing your business. For example, if you notice a high overhead this month, you can take the necessary steps to reduce your cost next month. On the same note, if you have low overhead this month, you can consider additional product lines to increase your profit.
Reduce Overhead Cost for Your Small Business
There might be cases when you have high overhead, and you feel that you didn't generate enough profit for the month. Don't panic just yet! Here are a few tips on how you can cut your overhead costs for small businesses:
1. Consider remote working.
Several companies were forced to adopt remote working when COVID-19 happened. Since then, many companies have considered large-scale remote work setups because this system significantly reduces overhead costs. Scrutinize your company and see which position is best suited for this setup.
2. Automate your tasks.
Everything is in the cloud now, and several services allow you to automate your daily tasks. Instead of hiring additional staff to work off your plate, try automating functions like invoicing, client follow-ups, and appointment scheduling.
3. Invest in culture and reduce retention.
You'll stop hiring to save on costs if you've hit the right number of employees. But more than that, you have to know that it's crucial to a company's overhead costs to focus on keeping the employees that you currently have. Employee turnover costs billions of dollars. In the USA, companies spend $1 trillion annually on employee turnover.
4. Go green.
Your utilities can really add up if you're not very careful. Use more eco-friendly alternatives like LED bulbs and choose a space that lets in more light. Go paperless if you need to! A lot of companies have adopted the paperless setup and are being lauded by their customers.
5. Consider renting instead of buying.
If you need specific equipment to run your business, try renting or leasing. You don't have to worry about maintenance, upfront payments, or repairs if you do--and you get the equipment that you need.
6. Hire an accountant.
You might think that this is counter-productive, but it isn't. Hiring a professional accountant to handle your finances will help you improve your accuracy and avoid financial cost mistakes. Your accountant can also help you identify areas where you can get tax deductions and help you increase your profit.
7. Audit your software subscriptions.
When starting your business, you probably were in a frenzy to sign up for different cloud services. Double-check your subscription and see if there's anything that you can combine. For instance, if you pay separately for your website, email marketing campaign, lead generation service, and domain, consider signing up for Strikingly.
Automate & Reduce Overhead Costs with Strikingly
Image taken from Strikingly
Strikingly, primarily, is a website builder that allows you to create websites with zero code. The website editor is ridiculously easy to use, and you can set up your website online in 20 minutes or less.
Strikingly offers 200+ templates that can fit your business perfectly. All websites built on Strikingly are automatically optimized, so you don't have to worry about hiring developers that cost thousands of dollars to build a mobile version of your site.
Image taken from Strikingly
Strikingly's newsletter feature allows you to set up an email campaign to re-target your audience and get them to revisit your website. You can schedule newsletters and send them to specific segments of your site visitors. For example, you can create a newsletter that only sends to people who have purchased from your online store.
Adding a sign-up section to your Strikingly website lets you generate leads for your campaign. You can also use Strikingly's pop-up feature to generate more leads or alert your site visitors if you're having a sale.
Image taken from Strikingly
Understanding and calculating your overhead cost is a daunting task. Keeping your company overhead to a minimum without sacrificing product and service quality can be tricky. You will be surprised how much cutting small things, like going paperless, can add up over time and turn your high overhead into low overhead.
As a general rule, try to re-evaluate your financial situation on a regular basis. You can do it monthly or quarterly (but don't do it yearly--a year is a very long time). Keep track of your overhead costs and control them as soon as early as day one.
It's the only way to manage and scale your business fast.