What Is Overhead and How to Reduce Overhead Costs
What Is and Isn't Classed as Overhead Costs
Business overhead costs are expenses that are related to the day-to-day running of a business. Reducing overhead costs is important in a business downturn.
Overhead expenses are independent of revenue and must be paid whether the business is in a profit or loss position. Overhead does not include expenses arising from the production of goods or services. For example, if your business is making furniture, the cost of lumber is a raw material and so is not included in overhead.
Overhead can include fixed monthly or annual costs (such as leases, insurance, or salaries) or expenses that vary from month to month due to the level of business activity (such as sales promotions or repairs).
Should You Reduce Your Overhead?
When business is slow, cutting overhead is normally one of the easiest ways to reduce losses and return your business to profitability. Raw materials, inventory and other non-overhead expenses used to create revenue are vital to the business and usually more difficult to cut down on.
Below are some suggestions for reducing some of the most common overhead expenses.
Typical overhead expenses include:
Rent – lease costs of the business premises (or mortgage costs if purchased). For information on leasing versus owning see Should Your Business Lease or Purchase Commercial Space?
Utilities – includes electricity, gas, water, sewer, phone and internet service. There are a number of ways to reduce your utilities overhead and help the planet in the process. (See The Green Office Guide and 10 Green Business Tips). Mobile phone, long distance, and internet usage should be reviewed on an annual basis to determine the levels of service required – there may be potential cost savings from switching to lower-cost plans.
Insurance – Every business needs insurance coverage, which may include: property insurance for the business premises and equipment, general liability insurance to protect your business from liability arising from negligence, professional liability insurance to protect your business from liability arising from malpractice if your business is of a professional nature, business interruption insurance to protect your business in the case of unforeseen closure.
For more information on business insurance see:
Administrative – includes ongoing salary costs (wages and benefits), office supplies and equipment such as computers, copiers, etc. Unfortunately the easiest way to reduce administrative expenses in a business downturn is to cut staff, which is painful for both employees and management but often necessary to ensure sustainability of the business. Sometimes this can be avoided if employees are willing to job share, switch to part time, or take unpaid leave.
Other ways to cut administrative costs include reducing the use of supplies such as printer ink/toner, etc.
Maintenance and Repair – If your business relies on vehicles or specialized equipment, the overhead costs of maintenance and repair can be substantial. Examples include businesses that provide delivery services, landscaping, or equipment rental. Reducing overhead with passenger vehicles, pickup trucks, and vans can be achieved by switching to more fuel-efficient models such as diesels or hybrids. See also 10 Ways to Save Money on Gas.
Sales and Marketing – all expenses related to marketing your product or service, including wages, benefits, and incentive bonuses for sales staff, promotional materials, advertising, costs related to trade shows, etc. For ideas on reducing sales and marketing costs see:
Business Overhead Insurance (BOE)
According to the Social Security Administration, a person of age 20 has a one in four chance of become disabled before reaching retirement age. For small business owners there are overhead insurance policies available to cover monthly overhead expenses in the event that the business owner becomes disabled due to illness or injury. BOE plans can cover most overhead expenses including:
- Employee wages and benefits
- Mortgage principal and interest or rental payments
- Property taxes
- Accounting fees
- Business insurance
Note that BOE policies do not cover the cost of hiring temporary replacements - for example if an electrical contractor becomes disabled, a BOE policy does not cover the cost of hiring another electrician on a temporary basis.
Note also that BOE plans are designed to cover temporary periods of disability and as such have maximum payout periods. Personal disability insurance is available for long term or permanent disability.
Like to see even more ideas on how to reduce your overhead? Read 10 Ways to Cut Business Costs.