Keep Your Overhead Low
July 27, 2017
By Eduardo Landeros
In business, keeping your overhead expenses low is extremely important for the success of any organization.
Overhead expenses are related to the operation of the business and do not represent any direct expenses such as those incurred to produce a product or provide a service. In other words, these are expenses that have nothing to do with the product or service that you are offering, but rather to the operations of the business.
Business owners have control over these expenses and should be a top priority when defining a business concept or operating an existing business.
For most companies those include: rent, advertising, salaries and administrative costs, office supplies, travel, legal and professional fees, or insurance. Raw materials, direct labor, and manufacturing supplies are classified as variable costs, not overhead.
Rent is a big expense for many businesses, especially if your business is located in California and in a prime location. It is not uncommon to see rents for retail commercial spaces at $3, $4 or even $5 per square foot. So if you have (or want to have) a 2,000 square feet retail space at $5 a square foot, you are now looking at about $10,000 per month in rent plus maintenance and other additional costs that will bring your rent expense to about $11,000 a month.
Conservatively speaking, rent should be about 10 percent of your sales so if your rent is $11,000 a month, you’d have to sell about $110,000 a month. For many businesses, this is not doable. If your sales do not reflect these ratios, then you are paying too much in rent.
In my experience, this is a very common mistake business owners make when opening a business.
Location is important, especially in retail or the professional services industry, but at the end of the day it has to make sense. However, there are some industries where you don’t need to have a high foot traffic or expensive looking space to operate. A perfect example of this is real estate.
During the recession, I was working for the banking industry and learned a lot about being successful in business. I learned primarily from businesses that were able to survive the recession and analyzing those that did not. Real estate firms come to mind because as I recall, before the recession, real estate professionals were doing very well and many did not need large and expensive looking offices.
Home prices were high at the time and so were commissions. Anybody involved in a real estate transaction such as the agent, broker, mortgage officer, insurance, title reps, and appraisers was making good money. But many made the mistake of living a high end lifestyle, personal and in business, and agreed to expensive leases that killed their business when the recession hit. Nowadays, most real estate professionals work from home and brokers have a small office in industrial areas where rent is less expensive.
Do you really need to have a lot of people working in your office? Do you really need expensive equipment? Are you over insured? Is advertising costing too much? Can you do your own bookkeeping? Do you have to fly or travel instead of driving? Do you need an expensive lease? These are some questions to ask yourself if you aim to reduce overhead.
Businesses that have been able to survive for many years think of these and many more scenarios and plan ahead. Keeping your overhead low is a must and time should be invested in analyzing these expenses to ensure the longevity of any business. Think twice before making a financial decision.
EDITOR’S NOTE: Eduardo Landeros MBA is a Senior Business Advisor for CDC Small Business Finance, a nonprofit organization focused on Small Business lending and growth. Landeros is not an employee of La Prensa San Diego.