Overhead Expenses Explained

What are Overhead Expenses?

Overhead expenses refer to all the business costs that remain after covering your direct expenses. Direct expenses are those costs essential to delivering your product or service, such as materials, labour or shipping. Once these direct costs are accounted for, the remaining operational costs are classified as overheads.

Overheads are often considered the cost of doing business. They typically include:

• Rent or mortgage for office space
• Utilities and insurances
• Vehicle costs
• IT and computer expenses
• Office Supplies
• Depreciation

Additionally, overheads also encompass costs that you want to optimise for growth, including:

• Wages for sales, marketing, HR, finance, and administrative teams
• Advertising, marketing, and consulting fees
• Staff training and development

IN THIS ARTICLE:

→ What are Overhead Expenses
→ Types of Overhead Expenses
→ What Overhead Percentage Should I Aim For?
→ How Can You Manage Overhead Expenses?
→ Why Monitoring Overheads is Crucial
→ How can a Virtual CFO Help with Your Overhead Expenses

Types of Overhead Expenses

Overhead expenses typically come in 3 forms:

•  Fixed Overheads: Expenses that remain constant regardless of business activity (rent, insurance, admin salary)

• Variable Overheads: Costs that fluctuate with business activity (utility bills, office supplies)
• Semi-variable Overheads: Costs that have a fixed and variable component (phone bills with a base charge plus usage fees)

What Overhead Percentage Should I Aim For?

As a rule of thumb, overheads should be kept at 20% or below of your revenue. For example, if your monthly revenue is $1,000,000 and your overheads are $200,000, then your overhead percentage would be 20%. At this level, most businesses are considered to have an efficient operational structure.

How Can You Manage Overhead Expenses?

When managing overhead expenses, it's crucial to avoid the instinct to cut costs indiscriminately - your team won't be happy to lose their coffees. Instead focus on optimising and investing wisely. Here's how:

• Minimise compliance-related costs: Look for ways to reduce insurance, vehicle costs, and other fixed overheads. Shop around for better rates and cut unnecessary expenses.
• Maximise Return on Investment (ROI): When it comes to spending on people, marketing, and other growth-related overheads, the aim should be getting the best out of your return. Investments in your team, advertising, and consultants should aim to generate additional revenue and improve profitability.

By cutting only unnecessary overheads while optimising investments, you can lower your overhead percentage without hampering the business's growth potential - just be smart with the cuts. Turning one bin in the office into the only food scraps bin and re-using the liners for other paper only bins is a far better solution than cutting down on bins/regularly purchasing bin liners entirely.

Alternatively, there are other ways to reduce overhead costs, however they come with far greater risk that would require closer monitoring to ensure a successful implementation and that they don't come as a detriment to your business. These are:

• Outsourcing non-core activities: Hiring freelancers or contractors for tasks like marketing, IT, support, or HR can be more cost-effective than having full-time employees. Be careful of their performance and quality - it might be cheaper but is the cost-saving outweighed by the man-power and time effort required of a more senior member ensuring quality.
• Adopting Technology: When appropriate, use technology like cloud computing, management tools, or automated processes to reduce administrative costs. Again similar to employing someone from offshore, do thorough checks of the software to ensure it has a smooth implementation. Check with your team that will be using the technology or software that it's something they actually want and will buy-in to. Don't get fancy software for the sake of it - know exactly what you're going to get out of it and see through that you do.

Why Monitoring Overheads is Crucial

It's important to know what your overheads are, but it's not important to be religiously tracking them. Typically your overheads don't usually fluctuate - but when they do you need to know and act accordingly (is someone stealing pens again??).  Most fixed overheads should be reviewed once every 6-12 months when it is appropriate (e.g., insurance) and others on an ad-hoc basis. It's important to know your overhead ratio as it helps with:

• Impact on Profitability: Overheads directly affect the bottom line. High overhead costs can erode profits even if sales are strong.
• Cash Flow Management: High overheads can strain cash flow, especially in periods of low revenue.
• Scalability: Overheads can limit growth if they're not scalable. If overheads increase too quickly as the business grows, it can prevent you from reinvesting in the business.

How Can a Virtual CFO Help with Your Overhead Expenses

A Virtual CFO can play a crucial role in managing and optimising your overhead expenses, helping to improve profitability and operational efficiency. Here's how CFO Dynamics, as your Virtual CFO, can aid in this area:

1. Overhead Expense Analysis and Benchmark

A Virtual CFO would start by conducting a detailed analysis of your overhead expenses to identify key cost drivers. They will:

• Break down overhead costs into categories such as rent, utilities, administrative salaries, insurances, and marketing.
• Benchmark your overhead costs against industry standards (and from our experience with clients over the past 10 years) to see if you are over or under-spending in certain areas

2. Optimising Overhead Costs

Once the overhead expenses are analysed, working as your Virtual CFO we can create strategies to optimise these costs without compromising business operations. These might include:

• Cost Reduction: Identifying areas where expenses can be reduced, such as renegotiating contracts for services (utilities, office leases, insurance, etc.), or switching to more cost-effective suppliers.
• Process Improvements: Streamlining administrative processes to reduce waste, automate tasks, and increase efficiency. For example, adopting new accounting software or automating payroll systems to cut down on manual labour.
• Outsourcing non-core functions: Advising on whether outsourcing functions such as HR, IT, or accounting could be more cost-effective than maintaining these functions in-house. As a traditional rule, we tend to avoid this - It takes a while to shop around for the right off-shore superstar, but when you have that superstar they will provide plenty of value to your business.

3. Maximising ROI on Overhead Investments

Not all overhead costs are simply expenses to be cut; some are investments in your business's growth. A Virtual CFO will help you assess which overheads offer the highest return on investment (ROI), such as:

• Marketing and Advertising: Determining which campaigns or strategies are yielding the best results and cutting any underperforming activities.
• Employee Costs: Reviewing compensation and benefits to ensure you're gettiing the best performance from your team while maintaining cost efficiency.
• Consulting and Training: Helping you measure the effectiveness of consultants or training programmes, ensuring they provide tangible benefits to your business.

4. Budgeting and Forecasting Overhead Expenses

A Virtual CFO can help you create realistic budgets for your overhead expenses and forecast future costs based on your business growth. They will:

• Develop detailed overhead expense budgets that align with your overall financial goals and cash flow projections.
• Provide forecasting models to predict how changes in revenue or operations might affect your overhead expenses, helping you avoid unexpected cash flow issues.

5. Tracking and Reporting Overheads

A key function of a Virtual CFO is to track overhead costs in real time and provide regular reports that highlight

• Which overhead expenses are trending above or below budget.
• Whether certain departments or activities are exceeding their overhead allocation.
• The overall overhead percentage relative to revenue.

With these insights, you can make informed business decisions about where to cut costs or invest more strategically.

6. Cost Control Policies and Procedures

With CFO dynamics as your Virtual CFO, we will help establish policies and procedures that maintain control over overhead spending. These may include:

• Implementing approval processes for large or discretionary expenditures.
• Setting clear cost control guidelines across departments to ensure spending stays aligned with the business's financial strategy.

Effective policies prevent unnecessary spending and create a culture of cost-consciousness in the business. 

7. Scaling Overheads in Line with growth

As your business grows, overhead expenses can increase if not managed correctly. A good Virtual CFO ensures your overhead structure scales efficiently by:

• Reviewing fixed and variable overhead costs to ensure they grow proportionally to your revenue.
• Advising on where additional overhead spending (e.g., hiring new staff or increasing office space) is necessary or where it can be delayed until revenue justifies the expense.

By leveraging the expertise of a Virtual CFO, your business can streamline overhead costs, maximise returns on key investments, and maintain a lean, efficient operation that supports long-term growth.

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