Many business owners focus attention on the Overheads in a Profit and Loss (P&L) Statement, but they may not compare them relatively, (by percentage) to the Revenue. This has an impact on the profit.
What is different about the ‘Overheads %*’ is that it is a percentage, rather than just a number. A total of expenses is a useful figure for the Taxman to determine tax deductibility and it is also part of the equation in determining profitability i.e. Gross Profit – Overheads = Net Profit.
A percentage is a more meaningful indicator of financial health, because it measures overheads in relation to Revenue. E.g. if you have Revenue of $1,000,000 and Overheads of $800,000 this looks OK, because it means you made a $200,000 profit. If your Revenue is $2,000,000 and your Overheads are $1,800,000, this may still look OK because again it means you made a $200,000 profit. If you were measuring Overheads % the first scenario shows a result of 80% whereas the second scenario shows a result of 90%. This means you have more expenses relatively in the second scenario, even though you are making the same amount of profit.
The point is, that it’s taking up more resources to make the same amount of profit in the second scenario and undoubtedly more headaches for the business owner. Perhaps it would be better to decide on an acceptable Overheads % and strive for that, rather than just focusing on Revenue and ending up with less profit for more headaches.
The aim in business is to make more profit with the resources you have. Aiming for efficiencies and economies of scale should be the objective i.e. making more money with the same amount of resources. This is what makes a business more profitable and more valuable. It’s much easier to focus on one number being the Overheads % say, rather than getting too bogged down in all the numbers you see on a P & L. If you don’t have a budget it can be very difficult to know if overheads are reasonable anyway.
A business without a budget is like trying to find a new destination without a roadmap! Yet very few businesses have a budget, which makes it difficult to know how the business performs month by month. So do you need a budget? Ask yourself… are you planning to reach a goal in business… then you definitely need a budget.
It’s obvious why you would want to decrease your overheads, but it’s sometimes overlooked how big an impact this can have on the bottom line.
Here are Nine Ways to reduce Overheads:
- Simply shop around: It’s so easy to ignore potential savings because you don’t have time. The time spent saving on overheads could far outweigh the value of time spent on other things in business. Have a three quotes policy when purchasing any goods or services.
- Create competition: Shop around for more suppliers for your business. Don’t underestimate your value to suppliers as a customer. Look at what business you’ve done with them over a period and use that knowledge to seek better terms and pricing. If you are a good customer they should want to keep you.
- Reduce fixed costs: Rather than locking into fixed costs, try to utilise non fixed solutions like outsourcing or sub contract labour. That way you aren’t paying costs during downtime.
- Don’t pay high skill rates for low skilled work: Get the right people into the right jobs with clear job descriptions that meet the overall objectives of the business. Regularly review staffing levels in line with business development.
- Use technology: Such as VOIP, Skype, Zoom etc. Could an updated web site save staff time in your business?
- Have a budget and stick to it: Report on variances between actual and budget each month and investigate.
- Review overheads regularly. Have an ‘in depth’ review of overheads several times each year. It’s amazing how savings can be eroded and increases creep back in again.
- Use ‘Purchase Orders’. Don’t allow staff to spend money unchecked. You could save thousands of dollars by stopping spending that may be done smarter or cheaper before the damage gets done.
- Break-even Analysis. Understand your overheads, so you know how much you need to sell to cover them.
Remember every dollar saved on overheads goes straight to the bottom line! Note: In our QuickCall business example – every 1% saved in Overheads costs would add $3214 to the profit!
This is the percentage of Overheads compared to Revenue
Example Revenue $1.000,000
Overheads $ 300,000
300,000 1,000,000 x 100 = 30%
Look out for our next blog post for more detailed information about each of the Seven Key Numbers and ways to improve them.
If you don’t want to wait for the next blog post and you’re keen to get started improving your Seven Key Numbers right now…