Do you know most businesses fail due to high costs and cash flow problems? This cost issue occurs because of high overhead costs. Fundera, citing data from the Bureau of Labor Statistics, reported that 20% of new businesses fail during the first two years and 65% in 10 years. In addition, a CB Insights analysis of 101 start-up polls shows that lack of cash and pricing and cost issues are among the top five reasons for business failure. This data shows how important it is for small business owners to manage overhead costs to save their business.
In this article, we will discuss overhead costs and how to cut these costs and improve profitability.
What are Overhead Costs?
Overhead costs are not directly related to products or services but are ongoing expenses needed to support the business. They are called overhead costs because the entrepreneur has to bear them whether or not the company generates revenue. Overhead cost can be of three types:
- Fixed costs – like rent, mortgages, accounting, software, and insurance – remain constant irrespective of business performance.
- Variable costs – like shipping, legal, some utilities, office supplies, maintenance of equipment, and marketing – vary depending on sales volume.
- Hybrid costs – like salaries for management, sales commission, and general utilities – you pay even if the business is down but increase when business activity increases.
There are many ways to analyze overhead costs, of which the most popular ones are the overhead cost as a percentage of sales and/or as a percentage of labour cost. This overhead rate tells you how much-fixed cost the business will have to bear per product and/or per employee. This will help you determine product prices and make hiring decisions accordingly.
Five Ways to Reduce Overhead Costs
A high overhead rate is not sustainable as it could hurt the company’s margins. At the same time, a low overhead rate could reflect that the management is compromising on quality. Hence, an entrepreneur must maintain optimum overhead costs to help your business last long. Here are a few tips to reduce overhead costs.
Review Your Office Space to Reduce Rent Overhead
The right way to reduce business overheads is to start with the expense that takes a significant share of the overhead cost. Real estate is one of the most expensive overhead costs. You could reevaluate the size and location of your office and see if a smaller space or a different address would have any material impact on the revenue. Then, you can work out some options, like making some employees work from home or leasing shared co-working space.
If you own the office, you could probably sublease any unused rooms or floors to other smaller businesses and collect rent. That could partially take care of your mortgage expense. In addition, a smaller office or a shared office space will reduce utility bills and other office maintenance costs. The objective is to make every square foot count.
Some businesses require heavy machineries like a data centre, a truck, or factory equipment. See the usage of the equipment and work out the cost metrics. Question if it would be cost-effective to rent the equipment or buy it. If you do not have spare cash and usage is irregular, it would be a good idea to lease or rent the equipment. This will remove the burden of down payment, maintenance, and repairs.
You could also create a mix of owned and leased equipment. For this, you can analyze the average business use. You can own equipment sufficient to fulfil regular orders and lease equipment for one-off or seasonal cases.
Review Employment-Related Overhead Cost
Another significant expense for most businesses is wages and salaries. When starting a business, you are the only employee. But as the business grows, you hire employees to run the operations so you can focus on business expansion and strategies. Most companies hire staff during the boom period and make significant job cuts in a slow period. As a result, hiring and firing employees regularly adds to overhead costs and impacts productivity and morale.
More innovative hiring can go a long way. You can deploy many creative solutions to improve human resource efficiency:
- Hire employees with several skills and invest in their training to fill gaps.
- Brainstorm with employees and offer incentives for taking up more responsibility, reducing cost, and increasing revenue.
While firing employees has a cost, sometimes letting go of underperformers saves costs in the long term as they could drain your resources and employee morale.
You can look at hiring from another angle and not hire full-time employees for every task. Most business owners outsource operations or hire freelancers for accounting, legal, payroll, marketing, and customer care functions. This saves several overhead expenses like office supplies, office space and training. In addition, you only pay for the working hours. Moreover, it gives you the flexibility to terminate or scale the contract depending on the business performance.
Review Your Contracts with Suppliers
A business goes through ups and downs. Therefore, it is a good habit to periodically evaluate the contracts with suppliers and third-party providers and renegotiate terms depending on business needs. This would help remove unnecessary services and get you favourable deals.
Make Your Current Clients Your Brand Ambassadors
Many companies spend a significant amount on advertising and marketing. But you can scale back on these costs by making your clients your brand ambassadors. You can offer them incentives for referrals and word-of-mouth publicity. In the digital age, you can opt for targeted advertising to ensure every penny counts.
These are just a few generic areas where you can cut overhead costs and improve efficiency. But do not go overboard and cut down on necessary expenditures. An accountant can review your overhead costs and help you cut unnecessary expenses while bringing significant tax savings wherever applicable.
Contact Glenn Graydon Wright LLP in Oakville for your Corporate Finance Needs.
A skilled accountant can review your overhead costs and help you cut unnecessary expenses while bringing significant tax savings wherever applicable. At Glenn Graydon Wright LLP, our financial and small business experts can provide services to support your corporate finance needs and provide you with recommendations on implementing and streamlining your costs to work best for your business. To learn more about how Glenn Graydon Wright LLP can provide you with the best accounting expertise, contact us online or by telephone at 905-845-6633.