Overhead costs (sometimes called indirect costs) encompass all the expenses associated with running a business that don’t directly relate to producing the product or service. Some examples are rent, insurance, utilities, and salaries for employees that aren’t directly involved with the product.
Unlike direct costs tied to producing the product, overhead costs are often fixed. That is, they remain the same no matter how much money comes in. For example, rent doesn’t change with the amount of profit a business makes from the location.
Every company has at least some overhead costs. Even freelancers that work from home have to pay extra utility bills that are associated with a home office. For example paying extra electricity because they use the AC when working from home all day.
As overhead costs don’t directly generate profit, businesses must keep them to a minimum and prevent them from becoming a significant drain on revenues. Common SMB mistakes include:
- Over expanding and rapidly increasing the overhead costs required without having the necessary resources.
- Eliminating products and services without removing the associated overhead costs.
So how do you cut overhead costs and maximize profit margins? Here are seven tips to help you on your way.
- Review all overhead costs
Start by reviewing every overhead cost that’s currently on your books and identify ones that are:
– No longer needed.
– Too expensive for what they bring to the company.
– Can be potentially improved through greater efficiency.
Additionally, you should reconsider the payment terms for any overhead costs paid using credit. For example, can you reduce the total spending by paying more upfront?
Businesses can simplify this process by appointing a dedicated staff member to investigate overhead spending or implementing comprehensive accounts payable software to see all outgoing payments more clearly.
One thing you should always avoid is missing payments and incurring additional interest or late fees. These kinds of errors add unnecessary expenses that could be avoided through effective budgeting and cash flow management.
- Cut loose unneeded costs
Before getting creative, the easy part is removing any overhead costs that you no longer need. It’s unlikely that you have a lot of them, but you never know. You might be paying a software subscription you no longer need, or maybe you have an old storeroom of hardware or equipment that can be cleared out. Sell these unused resources and repurpose the space to add value to your business.
- Employee performance reviews
While laying off staff is not an enjoyable experience for anyone involved, there’s no getting around the fact that payroll significantly contributes to overhead costs. Review the performance of your existing workforce not directly related to the product and identify any underperforming individuals.
You may find that your business has too much middle management and not enough workers on the product side. You may also spot inefficient administrative processes that will need less staff once reconfigured.
- Outsource services
On a similar theme, there are many services where outsourcing is better than taking on a full-time employee’s full salary and benefits. Not everything needs to be done in-house, and sometimes paying only for the services you need can lead to real savings. For example, perhaps your SMB is growing, but you can’t afford or need a full-time accountant on payroll. Outsourcing where you only pay for what you need right now can be the ideal solution. This could be someone that oversees the books (a few hours a week) and gets more involved during tax season (once a year). When outsourcing, if circumstances change, you’re not locked into a long-term employment contract. Instead, you can simply stop using the service. Plus, outsourcing removes overhead costs associated with a growing workforce (office space and supplies, for example).
- Change business space
Paying rent for business space is another considerable overhead cost. While having lots of room to spread out your operations is nice, it comes at a high price. Perhaps it’s time to downsize your business space and figure out how to rearrange your workforce as well as any facilities or equipment.
You can also consider changing location. Why pay more, if you don’t need to be in the middle of a high-priced city? Depending on your operations and workforce, transferring to a cheaper neighborhood may be simple.
- Going remote
With the recent pandemic forcing many businesses to transition to remote work, many found virtual work life beneficial and actually enjoy the fact that they don’t have to commute to a physical office. So if your operations allow, now could be the perfect time to do away with the office entirely and go remote.
- Marginal gains
Don’t expect a simple process where one massive expense is removed to solve all your problems. Unfortunately, life and especially business, is never that simple. All overhead costs exist for a reason, and reducing the total spending will likely mean reviewing them all and finding small areas of improvement. Then, with a series of marginal gains, you can quickly build up savings and make a real difference to your bottom line.
Heading in the right direction
Reducing overhead costs is a great way to increase your operational efficiency, improve profit margins, and get your business moving in the right direction. What can seem daunting at first, quickly falls into place once you dig deep and consider what you really need, what you can do without, and what you can cut back on.
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