A Complete Guide to Overhead Costs for Small Businesses

SNEHA HULL | July 29, 2021

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The first and crucial part of building your small business is setting up finance for your business. Overhead costs for small businesses are also included in this broad category of business finance. An old proverb, “You need to spend money to make money,” gels perfectly with the business notion.

Business owners spend a lot of money creating a product or service, which is considered “direct costs.” Some expenses are not directly related to the creation of a product or service but aid in the operation of your business; these are referred to as "overhead costs" or "indirect costs." However, from an accounting standpoint, overhead costs are not considered expenses at all.

Small business owners have a lot of costs to consider especially overhead costs. Here are a few examples of overhead costs: a business license, accounts payable, invoices, office supplies, accounting, and legal fees, bank fees, and many more to pen down.

Business owners are behooved to be careful and make sure that their expenses should not outweigh their income. Business overhead is one area that most businesses face, and it is worth investigating further and managing it accordingly.

Overhead expenses consume most of the remaining space on your profit and loss statement. However, cutting your overhead costs will improve your business finances.

Let us further discuss few aspects of overhead costs and how to reduce overhead costs for small businesses.


What Are Overhead Costs?

Overhead costs are the indirect but requisite expenses for running a business. These costs do not directly generate revenue for the company, but they do not change as your business grows. Overhead costs must be borne even if no products or services are produced or sold for a period and cannot be
be avoided.

Here are few examples of overhead costs for small businesses:
  • Electricity bill, gas, water, internet, etc.
  • Rent for office spaces, warehouses, etc.
  • Business licenses and permits
  • Marketing and advertising materials.
  • Office supplies
  • Lawyer fees
  • Salaries and wages
  • Loan interests
  • Insurance for vehicles, employees, and properties.
  • Property taxes
  • The key is to keep track of your overhead costs and not let them interfere with your efforts to grow your business and turn a profit.

Once your concept of direct and indirect costs is cleared, the calculation of overhead costs becomes relatively easy.


Types of Overhead Costs

The overhead costs are divided into three main categories that can directly affect your small business fixed costs, variable costs, and semi-variable costs. Fixed costs are easily trackable. Below are few types of overhead costs for small businesses.


Fixed Overhead Costs

The majority of your business expenses fall under fixed overhead costs and do not change regardless of the profit earned by the company or change in the level of output; it remains the same each month. Fixed costs are easily tracked and managed as well.

Fixed costs are pretty predictable and are required to keep a business running smoothly.

Few examples of fixed overhead costs
  • Renting a manufacturing facility or a corporate office.
  • Insurance.
  • Fixed asset depreciation expenses.
  • Mortgage payments.
  • Administrative salaries.
  • Property taxes.
  • Software subscription fees.
Fixed overhead costs are stable and do not deviate from the amounts budgeted for them. However, there are a few exceptions, such as if sales exceed what the company budgeted for, in which case fixed overhead costs may rise as new managers and administrative staff are hired. More employees are added to the company.

Similarly, if you decide to purchase a few additional pieces of machinery to increase production, this will result in a permanent change in fixed overhead costs.


Variable Overhead Costs

Variable overhead costs are those that change depending on the business activity, such as sales volume. Variable costs rise as your sales rise and fall as your sales fall. Variable overhead costs, as opposed to fixed overhead costs, vary from month to month.

Here are some examples of variable overhead costs:
  • Legal expenses.
  • Overtime.
  • Shipping costs.
  • Consultation fees.
  • Office supplies.
  • Commissions.
  • Maintenance of equipment.
Unless the number of workers increases or decreases with production volumes, the labor involved in the production, or direct labor, may not be a variable cost.


Semi-Variable Overhead Costs

Semi-variable overhead costs have qualities of both fixed costs and variable costs. A business may incur such costs at any time, though the exact cost will vary depending on the level of business activity.

Utilities are classified as a semi-variable expense. These costs are only fixed up to a certain level of output. For example, the office’s electricity bill is a monthly cost but varies as per the season.

Semi-variable overhead costs include:
  • Utilities (power and water costs).
  • Company vehicle expenses (i.e., gas).
  • Travel expenses.
  • Hourly wages.

Ways to Reduce Your Overhead Costs

Go Paperless

Going paperless is a simple way to save money. Although it may not appear to be a high cost, paper and ink do add up. Instead, adopt technology such as a cloud-based system to store all of your vital corporate data online. This will save you time and money while also allowing you to keep track of details for a more extended period. In addition, going paperless is cost-effective too.

However, going digital also reduces clutter and makes it easier for business owners to stay organized. In the event of a computer or program failure, make sure you have a backup of all your documents.

Going paperless is an intelligent decision to reduce overhead costs for small businesses because of few advantages such as being environmentally friendly, easy access, and digital file system easy to organize.

Create a Systematic Purchasing Process

It's a good idea to appoint one person in the company to handle, examine, and authorize purchases so that he can see all the expenses that management plans to incur before they're paid. In addition, negotiating contracts and placing office supply orders should be the responsibility of this person.

By putting one person in charge of purchasing, that individual can devote all of their time to finding the most incredible deals. The individual in charge of purchasing should be a skilled negotiator who is not hesitant to ask for a discount. Request that your purchasing manager go shopping for better prices on the things you buy frequently. Consider rewarding your purchasing agent with a bonus if they achieve specific cost-cutting goals without sacrificing quality.

Lease Equipment

Purchasing equipment such as computers, photocopiers, and other necessities every year is a significant expenditure. As a result, leasing equipment is frequently the best option for businesses looking to reduce monthly costs. Renting or leasing equipment makes it easier to upgrade to newer versions of computers and other equipment. Additionally, while leasing, costs such as equipment repairs and maintenance will be reduced if not eliminated.

Tax benefits are frequently available for equipment leases. In addition, depending on the lease, you may be able to claim your payments as a business expense by utilizing specific legal provisions.

Leasing equipment is one of the most productive ways to reduce your overhead costs for small businesses.

Market to Your Existing Customers

Marketing to your existing customers can be a good strategy to reduce costs. This step reduces your marketing costs and shows that you care about rewarding loyalty, which gives your brand a boost.

Customers who are happy with your products or services are more inclined to tell their friends and family about them, and word of mouth is still the most effective marketing method.

Organic promotion from peers is more likely to be trusted by potential customers than paid advertising.

Choose a Business Credit Card That Suits You

Choose the best business credit card that suits you for your business expenses. Your company can benefit from credit cards in several ways. For example, Cash-back benefits, travel miles, or a point system are all available on cards targeted for corporate use.

When buying office supplies and paying for travel expenses with a credit card, these incentives can pile up quickly. First, examine the annual fees and interest rates associated with your credit card. Then, it could be time to apply for no-fee credit cards with lower interest rates.

Choose a credit card that is ideal for your company, particularly in credit limits, interest rates, and fees. This could be one of the methods to your cost-cutting.


Frequently Asked Questions:


What are typical overhead costs?

Overheads are business costs associated with the day-to-day operation of the business. Accounting fees, insurance, advertising, legal fees, interest, labor burden, rent, supplies, repairs, taxes, travel expenses, phone bills, and utilities are examples of overhead expenses.


How do you calculate overhead costs for a small business?

Divide the total overhead costs of the business in a month by the monthly sales to calculate the overhead rate. To calculate your overhead rate, multiply this figure by 100. A lower overhead rate indicates greater efficiency and profits.


Are overheads fixed costs?

Typically, overhead does not fluctuate with increases in product production, which is why it is a fixed cost. Mortgage or rent for buildings such as the corporate office are examples of fixed costs.

Spotlight

Clarksys

While your business moves full steam ahead, we work behind the scenes as your on-demand CIO to help you navigate the waters of global expansion. Clarksys is your technology partner, taking a holistic approach to your business's needs as you move into a new market, connect multiple locations, or expand onto a new continent. Using technology as an avenue for growth, we bring our decades of engineering and infrastructure expertise to your strategy.

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