Overhead Expenses: What They Are, How to Track Them, and Top Strategies for Managing Them

As a small business owner, managing your organization’s finances is one of your key responsibilities, including meeting your business’ financial obligations.

These obligations include the ongoing expenses related to your day-to-day operations. These costs are known as overhead expenses and represent the true cost of running your business.

At Catalyst Group ECR, we often see business owners wondering about how to track and reduce overhead costs. Improving visibility over where your revenues go and identifying the right strategies to reduce your business overhead costs will help increase your bottom line, make you more competitive, and unlock new opportunities for growth.

Read on to learn more about overhead costs and how to manage them.

 Reduce Overhead: Meaning and Definitions

An overhead cost can describe any expense that stems from running your business. However, overhead costs exclude direct costs and indirect costs linked to offering your product or service. These costs are known as product costs, inventoriable costs, or the cost of goods sold.

As a rule of thumb, your overhead costs should represent 35% of your revenues or less, even though this ratio can vary from one industry to another. If you run a start-up or recently launched your business, it’s not uncommon to see a higher ratio since you’ll have many direct costs linked to establishing your business.

There are three main types of overhead costs:

• Fixed overhead costs. Fixed costs are consistent and easy to predict. These operating expenses will remain the same regardless of business activity.
• Variable overhead expenses. Variable costs can change from one month to the next. This category can include a one-time cost directly related to a major expense or costs that vary based on your activity levels or seasonal needs.
• Semi-variable overhead costs. These mixed costs typically have a fixed base price and a variable component that can fluctuate based on activity or other factors.

Reducing overhead costs means looking for ways to manage the direct and indirect cost of running your business. The goal is to build a leaner business with cost-effective processes while gaining more visibility over where your money goes.

Examples of Common Overhead Costs

This non-exhaustive list should give you a better idea of the most common types of overhead costs your business is likely to incur:

• Payroll, including employee wages, benefits, and employee perks
• Various administrative expenses, such as accounting fees
• Rent for your office space or storage space
• Business mortgage and property taxes if applicable
• Utility costs
• Professional liability insurance
• Interest on your business loan
• Depreciation
• Business licenses
• Cloud-based software subscriptions
• Janitorial services
• Business travel
• Professional services, such as legal expenses
• Marketing costs
• Selling overhead, including commission or eCommerce platform fees
• Office supplies
• Technology and office equipment
• Purchasing and maintaining company vehicles
• Shipping costs

 Why Reduce Overhead Costs?

Tracking the different costs your business incurs and improving visibility over your spending will result in a healthy business. In other words, you need to know where your money is going to reduce unnecessary expenses and ensure the processes you spend money on are generating value.

Tracking and managing overhead costs is important for several reasons:

• It helps you plan ahead. You can anticipate fixed overhead expenses as well as semi-variable overhead expenses to better manage your cash flow.
• Gaining visibility over your operating costs can help you identify spending patterns or unnecessary expenses. These trends can support better decision-making and financial planning.
• Tracking business expenses is important for tax reporting and auditing purposes. Many ongoing costs are deductible, resulting in a lower business income tax bill.
• Once you have identified your top spending categories, you can take steps to reduce your overhead rate and increase your bottom line.
• Calculating your total overhead cost with accuracy will also inform your pricing strategy for your product or service.

Top Strategies for Reducing Your Company’s Overhead Costs

Reduce your overhead rate with these proven strategies for reducing expenses directly related to operating your business.

Outsourcing

The Business Process Outsourcing (BPO) industry is a thriving sector that offers a wider range of services designed to help businesses save money on administrative costs and other processes. Trusting a vendor to handle key processes often costs a fraction of the direct labor costs linked to maintaining an internal team.

Outsourcing IT is a common strategy. In fact, the IT outsourcing market is expected to grow at an annual rate of more than 10%.

 You can also outsource human resources, customer service, or marketing. Some businesses are also reducing administrative costs by outsourcing accounting and payroll or lowering their manufacturing overhead costs by relying on a partner for product development and production.

Automation

Automation is another key trend that significantly lowers the costs related to offering a product or service. With automation, businesses can rely on technology to perform repetitive tasks. This approach reduces workloads, enhances productivity, and allows employees to focus on the tasks where they can create the most value.

For instance, automating your marketing process can cut overhead by more than 12%. Other examples of processes you can automate include onboarding, customer support, invoicing, scheduling, payroll, purchase orders, and more.

Employee Management

Payroll is one of the most important variable overhead costs. It can represent as much as 40% of sales in some sectors like the restaurant industry.

The key is to find the right balance between offering competitive compensation and limiting labor costs. There are a few strategies you can use:

• Invest in recruiting and training to build a workforce that consistently creates value.
• A strong employee engagement strategy can go a long way in boosting productivity.
• Use software and automation tools to build a smart scheduling process and avoid overtime or overscheduling.
• Indirect costs that stem from high turnover can add up. Improve employee retention by creating a positive work environment.

Remote or Hybrid Business Models

The move to digital-first business models has accelerated since the pandemic, and more employees than ever are working in a remote or hybrid environment.

This approach can result in significant cost savings by eliminating rental costs and reducing utility bills for your office space. If going fully remote isn’t an option, you can explore renting co-working spaces to adopt a flexible hybrid model.

 While outcomes can vary, data suggests that you could save as much as $11,000 a year per employee by adopting a remote business model.

Review Your Contracts

Go over your list of suppliers and vendors. Review your contracts, identify other suppliers who might offer a better deal, or consider switching to a different billing model.

For instance, you can reach out to your Internet service provider or electricity company and negotiate lower rates. You can also implement energy-saving measures to reduce your bills.

 If you outsource any of your processes to a vendor, review your service-level agreement to make sure you’re not paying for services you don’t need. You can also shop around to find affordable office supplies vendors or compare the cost of different financing options to reduce what you spend on interest.

More Strategies to Explore

 These strategies will help you implement further cuts:

• Marketing can represent between 5 and 10% of your sales. Invest in solutions designed to track your ROI and identify the most profitable channels so you can maximize the value you create with these variable costs.
• Printing is an overhead cost that too many businesses fail to account for. You can use signs to encourage employees to be more mindful of their paper usage and environmental impact.
• Opting for the cheapest option doesn’t always pay off in the long term, especially when investing in fixed assets. In some cases, exploring financing options to cover higher upfront costs will result in lower variable overhead by helping you save on maintenance and repairs.
• Establish a purchasing or acquisition process with clear guidelines. You should determine who is allowed to choose suppliers and make purchase decisions. Adopting an allocation measure to limit how much a team or department can spend and encouraging employees to make purchase decisions as a team can go a long way in fostering accountability.
• Document all your processes and review your best practices regularly. You might find that cumbersome processes are causing inflated administrative overhead costs. This approach will also help you ensure that you meet all industry-specific regulations and avoid potential fines.
• If your selling overhead is high, you can offset costs directly tied to selling on eCommerce platforms by launching your own online store instead. Focusing on customer retention over acquisition can also result in lower selling overhead.
• Not all costs related to operating your business can be cut or reduced. However, you can improve your overhead rate by combining cost-saving strategies with projects that will boost your net income. For instance, you could look for new streams of revenue for your business.

Take Control of Your Overhead Costs With Catalyst Group ECR

Managing your overhead expenses is a key aspect of balancing your income statement and budgeting for growth. If you don’t have a clear picture of how much your business activity is costing you, it’s time to take a closer look at your overhead costs.

The good news is that you don’t have to do it alone. Catalyst Group ECR offers coaching services to help businesses like yours manage overhead costs more effectively. From conducting an overhead value analysis to identifying the best strategies you can use to lower costs, our approach will improve your small business’s financial health.

Contact Lori Moen at Catalyst Group ECR today to learn more about how we can help!