Have you ever wondered, “What is overhead and profit, and why are they vital to my business?” Good! You’ve stepped onto the path of financial savvy that can help your small business thrive.
The ideal overhead percentage for small businesses floats around 10-30%. It’s a vital target for a healthy enterprise.
“Overhead” sounds a bit technical, but it plays a leading role in your profit-making. And yes, this profit is the backbone of your company’s longevity. So, understanding these terms isn’t just helpful; it may save you serious money.
It’s time to take a closer look at these words. Keep reading to unravel the mysteries of overhead and profit.
What Is Overhead and Profit?
Overhead refers to the necessary ongoing expenses that keep your operations flourishing. Profit is the financial gain after all expenses and overheads are subtracted from your revenues.
Types of Overhead
An understanding of overhead expenses can improve your cost calculations. There are three main types: fixed, variable, and semi-variable.
Fixed Overhead
Fixed overhead expenses are consistent. They don’t change with the level of output in your business. Think of costs like utilities, insurance, and salaries for permanent staff.
Imagine you’re running a cookie bakery. The rent on your bakery is $1,500 per month, whether you sell one cookie or a thousand.
Variable Overhead
Unlike fixed overhead costs, variable overhead expenses change with your business performance. Consider the following example.
When you sell more cookies, your outstanding payments due from customers-or your accounts receivable-will increase. Simultaneously, you’ll find yourself needing to invest more in supplies to meet this demand.
Take, for instance, integral cookie ingredients like icing and sugar. Their cost jumps or dips in tandem with your cookie demand. These are your variable overhead costs.
Semi-Variable Overhead
Semi-variable overhead includes costs that have both fixed and variable components. For instance, your electricity bill.
No matter what, you’ll have a basic charge each month (fixed overhead). But the more ovens you use, the higher your bill will be (variable overhead).
Examples of Overhead Costs
Accounts payable are overhead expenses. This is the money you owe to suppliers. If you’ve got a high-interest credit agreement to pay off, that’s overhead too.
Utilities, administrative costs, and property taxes are all types of overhead costs. Skimping on these can hurt your business. Pouring more financial resources into them than required could also prove detrimental.
How to Reduce Overhead Costs
As a business owner, it’s your job to turn a profit. Reducing overhead costs can help increase your bottom line without impacting the value you give to your customers.
Decreasing Office Space Costs
Whether you’re a company of one or a hundred, office space is typically a significant expense. Going virtual might seem daunting, but many businesses are finding this to be a smart strategy for cutting overhead costs.
Why rent a pricey office downtown when you can lease a cheap virtual office solution? Not only does it save money, but it also reduces the carbon footprint.
Optimizing Utility Costs
There’s gold in going green! Eco-friendly choices, like fitting energy-efficient light bulbs or using less air conditioning, can bring down your utility bills.
Look around your workspace. If you have machines humming away in standby mode, consider pulling the plug on these energy suckers when not in use.
You may also want to review your utility contracts. Depending on your agreement with your provider, you may be able to negotiate for lower rates or better terms.
Streamlining Staffing Costs
One huge overhead area that’s often a touchy subject is staffing costs. Investing in your team is essential, but that doesn’t mean you have to burn a hole in your wallet.
Consider flexible staffing plans like part-time, temporary, or contract workers. It will save you from keeping a full staff during slower periods.
And remember, a happy team is often a productive team. So, employee engagement and targeted, meaningful incentives can drive higher productivity.
Revamping Purchase Practices
Consider bulk buying for non-perishable office supplies or negotiating contracts with suppliers for better pricing. Keeping a close eye on your inventory can also prevent overordering or waste.
Taming Admin Costs
Leverage technology to bring down administrative costs. If you’re still sending paper invoices, for example, switch to email or use invoicing software for more efficient billing.
Automation
Automation reduces overhead costs by streamlining operational processes. It eliminates labor-intensive manual tasks, lowering labor costs and freeing up employees to tackle higher-value work.
Automation can also lead to a reduction in human error, avoiding costly mistakes. Furthermore, it allows for more accurate forecasting and inventory management, resulting in less waste.
How to Improve Your Profit
One of the quickest ways to improve your profits is to increase the amount each customer spends on each transaction. You can achieve this by upselling. Your team will have to convince customers to buy a higher-end product or add-on.
Another option is cross-selling. This is when you encourage customers to buy related or complementary items. The key is to offer real value and make sure your suggestions are relevant to the customer’s original purchase.
Raise Prices
Increasing prices can be a delicate balancing act, but when done correctly, it can be a powerful tool to boost profitability. Make sure to communicate the reasons for the increase to your customers in a positive light, focusing on the added value they’ll receive.
Focus on Retention
It costs more to attract a new customer than to keep an existing one. Thus, focusing on customer retention can significantly improve profitability. Provide excellent customer service, encourage repeat business with loyalty programs, and seek feedback to improve customer satisfaction.
Increase Your Bottom Line
We’ve explored “what is overhead and profit,” as well as ways to optimize both. Reduce overhead expenses by decreasing office space, utility, and staffing costs. Automation also plays a crucial role in cutting overhead costs.
For improving profits, tactics like upselling, cross-selling, price increases, and customer retention prove beneficial. Remember, a close review of your account receivables always brings valuable insights.
Navigating business growth can be a complex journey, but knowledge is power. Visit our business section for more insightful tips and tricks to help your company flourish.