TL;DR: Overhead costs are essential, ongoing expenses unrelated to production that small businesses must manage wisely. This guide defines types of overhead costs and offers strategies to help small businesses track, reduce, and budget for these expenses effectively.
Even when your small business is thriving, the rent is still due at the end of the month. You have electrical and cooling bills on your desk, and a few of your licenses are up for renewal. The copier needs paper, the printer needs toner, and you need gas to get to a trade show at the end of the week.
All of those small, indirect expenses are overhead costs, and they can add up in small business.
One of the first major challenges new business owners face is how to manage these small, often predictable expenses. In this guide, we’ll define the overhead costs that small businesses face. We’ll also provide some actionable tips to help you manage them long-term so you can enjoy your profits.
Read on to learn what costs are included in overhead and how to afford them.
What Are Overhead Costs?
Businesses have many expenses that aren’t directly related to the product or service they provide. These are overhead costs, often known as operating costs. They include indirect material costs, labor costs, and miscellaneous expenses. These costs can remain consistent or vary with activity level, production volume, season, or company size.
There are three basic categories of overhead costs:
- Fixed overhead costs. Expenses that remain constant regardless of the business’s activity level. They include rent, insurance, and salaries for full-time employees.
- Variable overhead costs. Costs that fluctuate directly with business activity, such as raw materials, direct labor, and utilities. They can vary with production volume.
- Semi-variable overhead costs. Expenses that have both fixed and variable components. They may remain constant up to a certain level of activity but increase when activity exceeds that level. For example, overtime pay during busier seasons.
To calculate overhead costs, add all fixed, variable, and semi-variable expenses incurred over a specific period. This total provides a view of the business’s ongoing expenses.
It’s wise for small business owners to track and analyze overhead costs. It’s the best way to understand how much cash flow you need to operate at the most basic level. For many business owners, understanding operating costs is a strategy for lowering them, saving money, and increasing productivity.
What Costs are Included in Overhead?
The following overhead expenses may be included in your small business’s overhead costs. Not every category applies to every business. For example, remote-only small businesses may have fewer overhead costs overall, while in-person businesses may incur more.
- Rent and Utilities. Costs for office or facility space, electricity, water, and heating.
- Salaries and Wages. Employee salaries, wages, and benefits that are not tied directly to production.
- Administrative Expenses. Office supplies, software, and general administrative tools.
- Marketing and Advertising. Costs for promotional materials, digital ads, and marketing campaigns.
- Insurance. Business insurance policies, including liability and property insurance.
- Depreciation. Cost allocation of long-term assets, such as equipment and buildings.
- Professional Fees. Fees for accountants, lawyers, and consultants.
- Maintenance and Repairs. Routine upkeep of equipment and facilities.
- Licensing and Permits. Required business licenses, permits, and regulatory fees.
- Miscellaneous Expenses. Other indirect costs like travel, training, and subscriptions.
Over time, these small expenses can add up. Luckily, the majority of these costs are fixed and predictable. That allows you to budget for a consistent amount each month.
Likewise, overhead costs are often scalable. The wisest thing to do is ensure you’re aware of them, track them fastidiously, and do your part to manage them effectively.
How Small Businesses Can Manage Overhead Costs Effectively
Small business owners can take proactive steps to track and ultimately reduce their business’s overhead costs. The more knowledge you have about your specific, recurring operating costs, the more power you have to reduce them.
For example, new small business owners might not be aware that they can negotiate with vendors. You can reduce your variable costs by arranging to bulk-purchase items you use regularly at a lower rate. As a repeat customer, you may even be able to negotiate better overall terms, including a regular discount.
Another route toward reducing overhead costs is embracing automation. Automating routine tasks can lower administrative expenses while streamlining your operations. Investing in a great CRM system goes a long way toward optimizing your workflow. It can help with cutting costs while boosting productivity.
Likewise, you can outsource (or “SmartSource”) certain tasks, which may be less costly than paying a full-time employee.
Greener, more environmentally friendly choices can have an impact, too. Consider:
- A hybrid or remote workplace that reduces or eliminates rent and utility costs. It can also optimize employee time by eliminating commutes.
- An energy-efficient workplace that prioritizes LED lighting, efficient heating and cooling, etc, can reduce utility costs.
- A paper-free workplace can reduce the need for technology maintenance and consumable costs like paper and toner.
Even in green workplaces, there are strategies you can employ to keep overhead costs low. For example, ensure you’re auditing all web or cloud-based apps and subscriptions. Confirm you aren’t paying for subscriptions or software your team doesn’t really use. It’s very easy to lose track of recurring costs, such as membership renewals.
Consider involving your team in identifying waste and finding ways to cut overhead costs. As your front-line team, they are aware of which memberships go to use and which sit by the wayside. They likely have insight and opinions that can help reduce overhead and ensure your business thrives.
Learn More About Managing Your Small Business
Managing overhead costs is only one part of savvy small business management. Explore our free Small Business University courses to grow your skills and transform your business.