Introduction

Managing overhead costs is one of the most crucial yet challenging aspects of running a small business, because they can slowly drain your profits if left unchecked, making it difficult to grow or even stay afloat. Overhead costs for small businesses aren't just unavoidable—they directly impact your ability to remain competitive and profitable.

Understanding how to handle them is key to keeping your pricing sharp and your business thriving. In this guide, we’ll simplify everything: from what overhead costs are to how you can calculate and reduce them. Let’s dive into actionable strategies that will help you master your expenses and increase your bottom line.

Key Takeaways

- Overhead costs are indirect, recurring expenses that keep your business running but don’t directly generate revenue.

- They fall into three main categories: fixed, variable, and semi-variable.

- Calculating your overhead regularly can help you pinpoint inefficiencies and boost profitability.

- Managing overhead is vital to ensuring your pricing strategy covers all your expenses and helps you maintain a healthy profit margin.

What Are Overhead Costs?

Overhead costs for small businesses are indirect costs that are essential for the day-to-day operations of your company but aren't tied to any specific service or product. Unlike direct costs—like labor and materials, which you can directly link to a specific job or service—overhead costs are the background expenses that keep your business functioning.

For example, your rent, utility bills, and administrative wages are necessary to run your business, but they don't directly contribute to your revenue generation. These overhead costs must be factored into your pricing to avoid undercharging and losing money on jobs.

A common mistake many small business owners make is underestimating these costs, leading to reduced profit margins. Understanding the different types of overhead costs is the first step toward better managing them.

The Three Types of Overhead Costs

Fixed

These are the predictable expenses that don’t fluctuate based on your business activity. These costs remain stable regardless of how many jobs you complete in a given month. Common examples include:

1. Rent or Mortgage Payments: Whether you own or lease your business space, these payments are fixed and need to be paid regardless of how much work your business is doing.
2. Insurance: Business insurance, like property or liability insurance, typically comes with a fixed premium, even though it might be subject to annual adjustments.
3. Property Taxes: These are a constant expense that, like insurance, might vary slightly year to year but remain largely predictable.
4. Software Subscriptions: If you pay for project management software, invoicing tools, or other business applications, these subscriptions are often monthly or annual and remain constant.

While these costs don’t change much month to month, it’s important to keep track of them to ensure your pricing covers these ongoing expenses.

Variable

These costs fluctuate depending on the level of activity in your business. They are more difficult to predict, as they rise or fall based on external factors like seasonality or changes in customer demand. Examples of variable overhead costs include:

1. Marketing Expenses: If you're running ad campaigns or investing in lead generation, these costs can vary depending on your marketing strategy and results.
2. Office Supplies: Items like paper, pens, and cleaning supplies can be purchased more frequently during busier periods.
3. Shipping and Delivery: If you ship materials to job sites, shipping costs will vary depending on the number of orders or projects.
4. Overtime Pay: If your employees work additional hours during peak seasons, the overtime costs add to your overhead.

Since variable costs can quickly get out of hand during busy periods, they require careful monitoring.

Semi-Variable

Semi-variable costs are a mix of fixed and variable expenses. They are incurred regularly, but the exact amount fluctuates. For example:

1. Utilities: You’ll always pay for electricity, water, and gas, but the cost will vary based on usage. For instance, during colder months, heating bills may rise.
2. Hourly Pay: Regular employees receive the same base pay, but if you have to compensate them for overtime or additional work, this cost can increase.
3. Fuel and Vehicle Maintenance: If your business uses company vehicles, your fuel and maintenance costs will vary depending on how often you use them.

Semi-variable costs are often predictable to a certain degree, but they require close attention to avoid overuse or inefficiency.

How to Calculate Overhead Costs for Your Business

Calculating your overhead costs is the foundation of controlling them. Many small business owners overlook this step or make rough estimates, which can lead to underpricing and reduced profit margins. To calculate them, follow these steps:

1. List All Your Overhead Costs: Start by identifying all the costs that don’t directly relate to a job or service. Include fixed, variable, and semi-variable expenses such as rent, utilities, office supplies, and employee salaries.
2. Total Monthly Overhead: Add up all of these expenses to get your total monthly overhead cost.
3. Divide by Sales: Once you know your total monthly overhead, divide this number by your total sales for the same period. This will give you a sense of how much of your income goes toward covering overhead.
4. Multiply by 100: To convert this into a percentage, multiply the result by 100. This percentage is your overhead rate.

For example, if your monthly overhead costs are $10,000 and your monthly sales are $40,000, your overhead rate is:

(10,000 ÷ 40,000) x 100 = 25%

This means that 25% of every dollar you earn goes toward overhead expenses.

You can find more details on how to calculate overhead costs by clicking here.

Ideal Overhead Percentage for Small Businesses

So, what’s a healthy overhead percentage? For most small businesses, an overhead rate between 10% and 30% is considered ideal. However, this can vary significantly based on the industry and location. For instance, home service professionals might have lower overhead than manufacturing businesses, but higher than digital service providers.

If your overhead percentage exceeds 35%, it could signal inefficiencies that are cutting into your profit margins. This is where proactive overhead management comes into play.

Proven Strategies to Reduce Overhead Costs

While overhead costs are a necessary part of running a business, there are several strategies you can implement to minimize them and increase profitability.

Reduce Overhead Costs Through Recurring Expense Audits

One of the most effective ways to lower overhead is by auditing your recurring expenses. Many businesses continue to pay for subscriptions and services they no longer need. Review your software subscriptions, utility bills, and professional services to identify where you can cut back or negotiate better rates. For example, you may discover you're paying for premium software features you no longer use.

Go Paperless and Automate Tasks

Going digital is not only environmentally friendly, but also an excellent way to reduce overhead. By shifting to paperless operations, you can save on printing supplies, storage, and office space. Automating tasks like invoicing, scheduling, and payroll can free up valuable time and reduce the need for extra administrative staff.

Outsource Non-Essential Tasks

This can be a game-changer for small businesses. Tasks such as bookkeeping, IT support, or virtual receptionist services can be handled by professionals at a fraction of the cost of hiring full-time employees. By outsourcing these non-revenue-generating tasks, you can focus on growing your business and maximizing profitability.

Optimize Energy and Resource Usage

Energy consumption can significantly add to your overhead costs, especially in industries where heating, cooling, or electrical tools are in use. Simple adjustments like using energy-efficient lighting, unplugging equipment when not in use, and downsizing your office space can help reduce these costs. Additionally, if your team can work remotely, consider implementing hybrid or fully remote work models to cut rent and utility expenses.

Conclusion

Overhead costs for small businesses are unavoidable, but they don’t have to drain your profits. By understanding what these costs entail, calculating them accurately, and implementing strategies to reduce them, you can run a more efficient and profitable business. Regular reviews, audits, and optimizations are essential to ensuring that your overhead costs remain manageable while allowing your business to grow.

By mastering your overhead, you’ll set yourself up for long-term success and greater financial stability. Now that you’re equipped with the knowledge and tools to tackle overhead costs head-on, it’s time to put these strategies into action and watch your profits grow.