A healthy profit is essential to creating a strong foundation for growth and building up your small business. Focusing on your profit margin ensures you’re making enough money to keep the lights on, pay yourself, and expand your products and services.
There are three main areas you can tweak to maximize your profits:
- The selling price of the product or service—the amount that you charge the customer per unit
- The cost per item of producing that unit—costs that you pay for each unit you produce, such as sourcing, manufacturing, salaries, logistics, etc.
- The overhead costs in your business—costs that you pay regardless of how many items you sell, such as office rental, utility bills, or staff costs
While there’s plenty to say on setting selling prices and managing costs per item, in this article we’re going to discuss overhead costs. They’re often overlooked by small business owners who see these costs as inevitable and non-negotiable. But through understanding your overhead costs it is possible to bring them down, increase your profit margins, and support business expansion.
Common Types of Overhead Costs
There are plenty of different types of overhead costs, but some of the more common ones are:
- Staff salaries for your workforce not directly involved with producing each item (e.g. customer service and administration)
- Real estate costs for your office space (e.g. leasing, rental, or purchase)
- Utilities (e.g. electricity, gas, water, and internet)
- Financial costs (e.g. loan repayments, property taxes, insurance, and mortgage interest)
- Marketing costs for promoting your products and services
- Equipment or vehicle costs
- Professional costs (e.g. accounting, licenses and permits, and legal services)
Some of these costs will be “fixed” and some will be “variable.”
How Overhead Costs Impact Your Profit Margin
Overhead costs need to be figured into your profit margin because those costs need to be paid, regardless of how much or how little you sell. The easiest way to explain how this works is to use an example.
- You sell an item to the customer for $30 per unit.
- Your total cost per item to source, manufacture, pay staff, transport, etc. is $18.
- Your profit margin before overhead costs is $12 per unit.
The monthly overhead costs in your business are:
- Staff salaries: $10,000
- Office rental: $5,000
- Utilities: $800
- Other costs: $2,200
- Total overhead costs: $18,000
You need to account for these overhead costs in your profit margin, which depends on the number of units you sell. Let’s stick with the $12 per item profit before taking into account overhead costs.
- If you sell 5,000 units a month, you divide that $18,000 by 5,000 for an overhead cost per item of $3.60, making your total profit per item $8.40.
- If you sell 10,000 units per month, you divide that $18,000 by 10,000 for an overhead cost per item of $1.80, making your total profit per item $10.20.
- If you sell 20,000 units per month, you divide that $18,000 by 20,000 for an overhead cost per item of $0.90, making your total profit per item $11.10.
As you can see, the more you sell the lower your effective cost per item and the higher your profit margin. Now that we’ve discussed what overhead costs are and the impact they have, it’s time to reduce them.
How to Reduce Your Business Overhead Costs
Keep Staff Working at Home and Make it Possible for Onsite Staff to Work Remotely
The pandemic has already forced many businesses to move to remote-only working. This is vital to the health and safety of your employees, but it can also reduce your overhead costs. Remote-only working can:
- Reduce the amount of energy you need to use to heat, light, and run your office space.
- Reduce the amount of office space you need and associated lease costs.
- Reduce the cost of providing onsite amenities like parking, break rooms, coffee, etc.
You can then negotiate with your landlord or property owner to reduce your rental space and any lease costs associated with it. As staff work from home, you should also see a corresponding drop in the price of utility bills.
Use Contractor and Freelance Workers for Specialist or Limited Projects
It can be very expensive and time-consuming to hire new employees. Instead of taking on a permanent member of staff, use contracted workers like freelancers and other specialists, especially if you have a temporary project you need to get in place. By using contracted workers you can:
- Avoid the significant overhead cost of advertising, screening, interviewing, and onboarding an employee.
- Take on people who already have expertise and are focused on productivity and delivery.
- Eliminate costs to do with health insurance, retirement plan contributions, and similar.
You can find freelancers and contractors on many online marketplaces, or simply searching for “freelance” and whatever you need help with.
Work with Outside Professionals as Efficiently as Possible
Accountants, attorneys, and other professionals tend to charge by the hour for work, and they can be expensive! You can keep those costs down by:
- Staying on top of your accounting and bookkeeping and providing accurate, easy-to-file information to your accountant.
- Using legal templates and libraries for common documents like contracts, rather than paying an attorney to draft each one.
Consolidate and Rationalize Your Insurance or Loan Payments
Consolidation and rationalization is a great way to get your insurance and loan costs down:
- Talk to a broker about moving all of your business insurance to one place and getting a discount for holding multiple policies.
- Look at refinancing your small business loan or getting a lower-cost startup loan.
Other Techniques to Lower Overhead Costs
There are many more ways you can reduce overhead costs, including:
- Insulate your workspace and use low-energy bulbs and equipment to keep energy costs down.
- Narrow your marketing and advertising spending to focus only on your most profitable and popular products.
- Keep up with preventative maintenance for essential equipment and vehicles to avoid high repair costs.
We hope you’ve found this guide to lowering your overhead useful, and that it gives you enough of a profit margin to really grow your business. Onwards and upwards!