The simple tactics in this article can have a huge impact on the Overheads Percentage result, and ultimately, the value of your business.
‘Overheads' is not a new term to business owners. You see them each month or year when you print out a report from MYOB or when you get a Profit and Loss statement from your Accountant. It's a listing of what you have spent money on over a period, e.g. Bank Charges, Rent, Salaries, etc.
These expenses are different to Cost of Sales (COS), in that COS mostly only happen when you sell something, whereas Overheads occur whether you sell anything or not.
Overheads Percentage is an often-overlooked number in business
‘Overheads Percentage' is calculated as follows:
Overheads Percentage = Overheads/Revenue x 100
e.g. If Overheads are $500,000 and Revenue is $700,000 then Overheads Percentage is 71.43%
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. For example:
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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.
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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.
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If you were measuring Overheads Percentage, the first scenario shows a result of 80%, whereas the second scenario shows a result of 90%.
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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 is taking up more resources to make the same amount of profit in the second scenario, and undoubtedly more headaches for the business owner.
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, that is, making more money with the same amount of resources. This is what makes a business more profitable and more valuable.
Percentages enable business owners to clearly see changes and manage those overheads and costs whose percentages change. This way, businesses can consistently achieve gross profit margin and net profit percentage.
If Overheads Percentage is an important indicator of financial health, how can you improve it?
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Know what your Overheads are
For every accounting period you need to know what your Overheads will be so that you can budget and project what your profit and cash position will be.
Planning Overheads is generally part of budgeting and forecasting. I have often heard business owners say they can't do a budget because they have no idea what they will sell in the future. This may be true, but most business owners have a fair idea of their overheads, e.g. Rent, Salaries, etc.
This is a great place to begin budgeting because once you know your Overheads and Costs you are then in a position to determine how much Revenue you need to cover both. This is called Break-even, that is, the amount you need to sell to make neither a profit nor a loss.
Once you know your Break-even point you can then plan what you need to do to make a profit or avoid a loss.
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Enter Overheads into whatever accounting system you are using as a Budget
It's a good idea to enter them for each month so that when it gets to the end of each month you can compare your actual results to the budget. This will enable you to see very quickly where variances are occurring and take quick action to correct the situation or alter the budget if you have miscalculated.
- Purchase Orders
A Purchase Order is a simple piece of paper that all staff must complete prior to spending any of the company's money. This paper is then handed to a director to authorise, prior to the order being placed. Sounds like a simple concept doesn't it? So why don't all businesses do it?
Not having a Purchase Order system in place is like giving staff an open cheque book. You as business owner are usually in the best position to know your financial position as well as many other important factors in the business' operation.
For example, a staff member may not know that something they are about to order will shortly become obsolete, whereas you do. If they just go ahead and order it, you get stuck with it. If they had asked you to sign a Purchase Order you could have avoided the wastage.
It may sound like a bit of a pain, but believe me, it's worth it and can save your business many thousands. Once staff get the message they can't just spend the company's money at will, it's amazing how much more careful they will be.