As a leader or CEO, you’re juggling a lot. You’re creating innovative businesses, chasing the next big idea, and leading with impact. But, one common issue might be creeping up on you without noticing it – overhead costs. Sure, they’re part of doing business, but if left unchecked, they can start to nibble away at your profits, stifle your plans to grow, and mess with your cash flow.
In this post, I’ll show you some straightforward ways to keep an eye on your overheads and ensure they’re not getting out of hand. We’ll go through what you need to check on regularly, how to audit your expenses to avoid unnecessary spending and the types of reports that can quickly show you where you need to tighten things up.
Overhead costs might not be directly linked to making your product or service, but they’re still a key part of your business. Regularly checking these costs helps you understand your profitability better, spot chances to boost profit margins by cutting unneeded expenses, and lets you plan and budget more effectively.
You can forecast what you’ll need financially in the future, plan for growth, and make sure you’ve got enough money coming in to keep things ticking over. For example, you might be spending a lot on software subscriptions. Are all of them really necessary? Are there cheaper options out there that do the same job? Or maybe you offer a service that costs a lot but isn’t bringing in much money. Would it be better to cut it loose? By closely monitoring your overheads, you can make smart decisions to improve your business performance and profitability.
The thing is, a lot of business leaders miss this. They get into a routine, running their business daily without really checking things, which can lead to nasty surprises when it comes to overhead costs. Not planning properly, not keeping a close watch on expenses, and not seeing the impact costs have can lead you down a slippery slope.
High overhead is often the number 1 reason businesses are not profitable.
Here are the checks and balances I put in place to avoid unexpected overhead surprises:
- Overhead analysis
- Software tools expense audit
- Job costing reports
I’m confident these tips will help you take control of your overheads, making your business run more efficiently and profitably.
Overhead analysis
Overhead costs are the expenses that keep your business up and running, even when you’re not bringing in revenue. They aren’t directly tied to creating a product or service but are critical to your operations. The tricky part is that if overhead costs swell up, your profitability can take a hit, especially during challenging market conditions.
For small businesses, maintaining low overhead is paramount. It offers agility, the ability to pivot rapidly, alleviates pressure to generate revenue, and stretches your runway.
In this section, I’ll share a straightforward method I use for overhead analysis in small service businesses. This process could put your business on a steady course toward better profitability.
1. Identify all costs not linked directly to service delivery:
- Teams and tools dedicated to sales and marketing.
- Operations, finance, and all other business support teams.
- Software tools not used directly for service delivery.
- Business insurance, bank and credit card fees, and legal expenses.
- Optional expenses like travel, training, learning, etc. (Given that the companies I work with are fully remote, I don’t consider office space here).
2. Analyze revenue, profit, and overhead trends:
Watch the ratio of overhead to revenue over time. If the percentage of overhead from revenue is increasing, your profitability is likely dwindling. A well-optimized company should aim to decrease overhead costs as a proportion of revenue over time, often through technology and automation.
3. Review overhead per category and strategize cost reduction:
When you break down overheads by category, you can start to identify areas where you can make savings or work more efficiently. Here is a simplified approach:
- Sales and marketing – these expenses are pivotal because they drive revenue. However, they also represent some of the most significant overhead costs. Implementing software and tools to automate and optimize processes as much as possible is a sound solution.
- Operations and finance – these overheads can be managed effectively. What you need is an operations expert well-versed in leveraging the right tools and optimizing resources. You’ll be amazed to see that with well-automated processes, the operational costs for a 30-person team can be similar to those for a 100-person team.
- Insurance, banking, and legal expenses – while essential, there’s room for negotiation. You can renegotiate agreements or switch service providers. An annual review of these services to seek more cost-effective alternatives is a practice I recommend.
- Optional costs – include expenses like travel, training, learning, etc. While these costs contribute to business growth and employee satisfaction, it’s worth considering if all are necessary or if more cost-effective alternatives are available.
Remember, understanding your overhead costs and keeping them under control is critical. It’s about knowing where your money is going, making smart spending decisions, and keeping your business profitable. Stay on top of this task consistently. And know you’re not alone in this – I’m here to help you optimize your overheads and steer your business towards sustainable profitability.
Software tools expense audit
Every business owner should regularly audit their software expenses, and I recommend doing so every 3 months. A monthly check can prove beneficial if your business heavily relies on technology. The aim is to identify which software costs can be slashed without hampering productivity or reverting to manual work.
Here’s my step-by-step guide to simplifying the process:
- Automated reports – set up a system where you get automated reports for your software tool expenses directly in your inbox. This can be monthly or quarterly, depending on your preference.
- One-by-one check – go through each tool in your report individually. Look at the tools that haven’t been used in the past month or longer. These are your prime targets for cancellation or suspension.
- Tip: most tools allow you to re-subscribe in the future without losing too much data. If a significant amount of data is lost, consider downloading it before canceling.
- Review paid-per-seat software – if you’re paying for software per-seat, you need to examine how many seats you’re paying for versus how many are being used. This can often be a drain on resources. Delete any seats that are not in use.
- Note: don’t keep seats ‘just in case’. If they’re not being used regularly, they’re costing you money.
- Market watch – keep an eye out for new tools in the market. Are there any cheaper alternatives that do the same job or perhaps even more? The wonderful thing about technological advancement is that it makes things more affordable. While HR costs may be rising, you can rely on software costs to decrease. Something might need to be changed if this isn’t happening for your business.
You’ll be surprised to see how much you can shave off your expenses. And remember, this isn’t a one-and-done process. The more consistent you are with your audits, the more money you’ll save in the long run.
Job costing reports
Job costing reports are a crucial tool in understanding your business’s profitability. They offer a deep dive into the cost of delivering your service, including labor and tools. Essentially, these reports complement overhead reports, providing a fuller picture of your business’s health.
Here’s a simple guide to harnessing the power of job costing reports:
- Reliable cost tracker – the first step is to set up a reliable system for tracking costs per project. This includes both human resources and tools used. A good tracking system is the backbone of insightful job costing reports.
- Splitting costs – when a resource (human or software) is used across multiple projects, you’ll need to decide how to split the costs. Two common methods are:
- Equally i.e., each project shares the cost.
- Proportionally, i.e., the cost is divided based on each project’s revenue.
Remember, which method you choose depends on your business strategy.
- Automated reporting – develop an automated report system that pulls data from your cost tracking and revenue systems. Use a simple formula to generate a wide range of insightful data:
- Gross profit per project – this shows how much money you make from each project after deducting the costs.
- Top most profitable projects – knowing which projects bring in the most profit can help you focus your resources effectively.
- Top most profitable services – this gives you a clear idea of which services are the best for your bottom line.
- Trending services and projects – keeping track of which services and projects are going up or down in profit can help you respond to changes quickly.
By examining job costing reports, you’ll better understand your gross profit margin, which reflects your pricing and labor costs. For instance, if your gross profit margin is decreasing, you can analyze why and seek areas to optimize. Without much room for optimization, it signals a need to scrutinize overhead costs to maintain healthy profitability.
On the other hand, if your gross profit margin is increasing, it indicates you have more space for optional expenses, which fall into the overhead category. Job costing reports are a key tool in managing your business’s profitability and efficiency.
Final Thoughts on Controlling Overhead and Increasing Profitability
Keeping overhead under control and boosting profitability isn’t just an essential business operation. It’s the lifeline of any thriving business. By understanding and managing overhead costs, businesses can easily optimize their expenses, make strategic decisions, and navigate the financial landscape.
Here are the key takeaways from this article:
- Regular overhead analysis – this practice provides insights into areas that might be soaking up resources without directly contributing to your service or product. Staying nimble, streamlining operations, and maintaining lean operations are all benefits of regular overhead analysis.
- Software tools expense audit – a surprisingly effective way to identify cost-saving opportunities. Regularly reviewing software subscriptions, and ensuring that only the necessary tools are being paid for, can result in significant savings.
- Job costing reports provide a comprehensive look at your service delivery costs, helping paint a vivid picture of your profitability. When coupled with overhead analysis, they indicate where adjustments need to be made and where there’s room for flexibility.
- Balancing act – managing overhead isn’t just about cutting costs—it’s about making smarter, more efficient decisions that balance investment in the right tools with optimizing operations.
- Staying resilient and profitable – by keeping a close eye on overhead, businesses can remain resilient, competitive, and profitable, no matter what the market throws at them.
In conclusion, understanding and managing overhead costs is not just about saving money—it’s a fundamental aspect of successful business management. With a regular system of checks and balances, businesses can survive and thrive in any market condition. It’s not always an easy task, but with careful planning, strategy, and ongoing vigilance, it’s a challenge any business can meet head-on.