Those who're trying their luck in the field of entrepreneurship, and are already doing some small businesses, must be aware of a decently vague term, called overhead cost. Though this term may appear vague inherently, it can have a great impact in saving you some precious money when you're running your business.
Stated in simple accounting terms, overhead costs are business expenses, that are not directly involved in contributing to the profit, but they're vital to run your business. This may include anything like office space, office stationery, office furniture, cafeteria, etc. For small businesses, extra expenses matter a lot, because capital investment is limited and so maximizing profit and preventing loss is the only key to survival, especially in times of harsh economies and destabilized markets.
Guide to Cutting Your Operating Costs in Business
Regular expenses that are not directly involved in producing goods or providing services are known as overhead costs. It is obvious that you can't keep your overhead expenses zero. Let us take one example. Electricity is a basic need in the offices, and so you can't prevent employees from using it! Yes, you can manage electricity usage effectively, and even ask employees to use resources in the office premises frugally. This will in turn lower the overhead costs for your business, saving huge resources of money. Here are some more tips to manage the extra costs.
Enlist Your Business Expenses
Starting a business is not easy, and if you have been in the business world for sometime, you must be aware of the fact that it is a daily battle you need to fight to survive. Hence, you got to manage your overhead costs and be proactive in listing all your business expenses. Now, what you list requires business judgment and understanding. To put things in perspective, consider the fact that you own a small printing press, where the need of computers and electricity is essentially 24 x 7, and so you can't list electricity as your overhead cost. Some tangible overhead costs in business field are as follows:
- Taxation, audits and penalties that, changes in government rules and laws can bring.
- To maintain efficiency of employees and provide them all comforts to work, known as 'downtime costs', you need to be willing to spend some extra money.
- Any changes in bureaucratic and regulatory changes.
- Any legal battles and disputes that can result in some court room cases.
- Natural disasters and economic downturn, that are inevitable, can cause you to spend some money on the damage done.
- In cases of theft or damage of products, you got to pay the extra money.
- Any unplanned and unexpected development in infrastructure of the building.
After you have enlisted your monthly overhead expenses wisely, it is time to introspect where you can lessen your expenses. Refer to your industry standards and inquire with companies of the same business, as to what parameters they categorize as 'overhead costs'. Knowing what exactly constitutes these costs, can help firms to come up with cost cutting ideas and in turn save resources.
Do Some Math
One of the vital aspects of managing these costs is that, you should calculate two things viz.
- Proportion of the costs compared to sales (Overhead cost ratio).
- Overhead cost as a percentage of labor cost or human resource put in.
The overhead cost ratio equals to the ratio of overhead costs and sales of a firm depending on monthly, quarterly, half-yearly and yearly basis. Overhead cost ratio just like margins, is used to understand how the profits of a firm are changing. You can also calculate overhead cost as a percent of sales. For example, if the monthly revenue of your firm is $100,000 and your overhead costs per month is $25,000, then the overhead cost percentage over sales is, (25000/100,000)x100 = 25%.
On similar lines, you can calculate how efficiently your resources are being utilized in running your business. To do this calculation, simply divide overhead costs by total labor cost and multiply the result by 100 to express it as a percentage value. The lower the percentage, the higher is the efficiency of the resources being utilized. You may also hire a professional chartered accountant for managing your finances.
The above tips for saving money on overhead costs, can help small business owners and entrepreneurs gain a competitive business advantage. Moreover, the saved money can indirectly be invested in increasing product quality and to price the products more competitively.