In business, there’s a well-known phrase: you’ve got to spend money to make money. That’s true, up to a point. But it’s important to spend money in the right places, rather than wasting it in areas where you could cut back.
Overheads are one area that can quickly become a drain on revenues and can be cut back with minimal risk. Find out everything you need to know about overhead costs for small businesses, from our overhead cost definition to how to reduce overhead costs in business.
Overhead cost definition
First off, what is an overhead cost? Put simply, overhead costs are costs that are associated with running your business, but don’t directly contribute to the production of a product or service – otherwise known as an indirect cost.
There are many types of overhead costs for small businesses, including insurance, administrative costs, professional expenses, licenses and permits, property taxes, utilities, rent payments, and office equipment. While overheads are critical to your business, they don’t have a direct link to profit generation.
Calculating overhead costs per employee
As a small business owner, it’s important to know how to calculate your overhead costs. There are lots of different methods that can be used but calculating overhead costs per employee tends to be one of the most effective. To make the calculation, you just need to follow these steps:
Firstly, calculate the labor cost. This isn’t restricted to salary. You should also factor in health benefits, pension, retirement benefits, and vacation pay.
Then, calculate the total overheads of your businesses, adding up all your indirect costs.
Next, divide the overhead costs by the total labor cost, which tells you the net cost of an employee to your business.
To start calculating overhead costs per employee for yourself, you can use the following formula:
(Monthly Overhead / Monthly Labor Cost) x 100 = Percentage of Overhead Cost to Labor
How to reduce overhead costs in business
While overhead costs for small businesses are important, they aren’t beyond your control. Though many of these costs are fixed – meaning that they don’t vary from month to month – there are ways to reduce or even eliminate some of these costs, giving you a larger profit margin and helping to keep your cash flow healthy. Here’s five of our top overhead cost reduction strategies:
Do a deep dive on your overhead costs – It’s important to review all your overhead costs and mark off items that are too expensive, open to efficiencies, or unnecessary. Once you’ve identified an overhead cost that can be reduced, such as a license you no longer need but are continuing to pay for, you can take steps to eliminate it.
Outsource specific duties – Rather than hiring new employees for certain tasks, such as accounting or tax preparation, consider outsourcing to third-parties. This removes employee-related costs like health benefits and pension. Then, if you need to drastically cut your overheads further, you can do so much more easily than hiring/firing talented employees.
Embrace remote working – From utility bills to monthly rent, many of your overhead costs are likely to be linked to your physical office. Remote working is increasingly popular, and by shifting to a remote-first work culture (with a small hub office for business meetings, interviews, and so on), you can shred your overheads and put your business in a great position moving forward.
Reconsider software upgrades – Another great overhead cost reduction strategy concerns expenses relating to computer systems and software. There’s very little salvage value for computers and software, so even if your employees are pressing you for the latest upgrades, think about scaling back. Rather than unrolling pricy software across your entire team, it may be more cost-effective to only purchase licenses for employees who really need them.
Go paperless – Although it may not seem like a major expense, paper and ink adds up, particularly if your business deals with lots of different documents. Try looking for paperless alternatives to traditional business processes.
We can help
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.