Overhead Costs for Service-Based Businesses
As a service-based business owner, having a full schedule and a ton of ongoing business is awesome. But it doesn’t necessarily mean that you’re making a healthy profit.
That’s because business costs, including overhead, tend to increase year after year. If you aren’t keeping close track, you might be spending more than you’re making.
What are overhead costs for small businesses?
In a business, overhead refers to the indirect costs required to run your business. Here are some common overhead cost examples:
- Office rent payments
- Property taxes
- Utilities, like heat, water, and electricity
- Cell phone bills, website hosting, and internet
- Office supplies (administrative overhead)
- Office cleaning or janitorial services
- Licenses and permits
- Insurance payments
- Company vehicle maintenance
- Accounting or reception staff wages
- Marketing costs
- Administrative software
READ MORE: 30 small business tax deductions to save money when filing
Overhead costs are necessary for keeping your business running.
It’s important to remember that expenses for specific jobs are not considered overhead.
For example, materials and direct labor are not considered overhead costs. You calculate them individually for each job.
Equipment repairs are overhead costs because your business can’t function without them.
READ MORE: Learn the difference between overhead and operating costs
What are the different types of overhead?
There are three types of overhead costs: fixed, variable, and semi-variable.
- Fixed overhead: consistent costs that aren’t expected to change, like rent or insurance payments. Fixed overhead costs tend to remain the same regardless of how busy you are.
- Variable overhead: costs that can fluctuate month-to-month, like marketing expenses. Variable costs can change based on your business activity. They may increase during your busy season and decrease during your off-season.
- Semi-variable overhead: costs that are always there, but that may change slightly from month-to-month, like electricity costs at your office. For example, you may pay a base rate for electricity and then an additional amount per kilowatt depending on your usage.
How does overhead affect profit?
Overhead plays a major role in the profitability of your business. If you don’t account for business metrics like overhead costs when setting and adjusting prices, you could end up making little to no money on completed jobs.
The amount you charge for a service needs to:
- Cover job-specific costs like materials and labor
- Contribute to overhead costs like office rent and utilities
- Include a healthy profit margin
Including overhead costs in your pricing helps you to set service prices for profit.
When you have a firm understanding of your total business costs, you’ll be able to price jobs for profit every time.
How do I calculate my overhead rate?
To calculate your overhead rate, start by adding up all of your monthly overhead costs for a given month. Let’s say your total overhead costs are $10,000.
Next, add up all of the money that you brought in from jobs in the same month. Let’s say you made $40,000 in sales.
To calculate your overhead rate, take your monthly overhead amount, and divide it by your monthly sales. Multiply it by 100 to get a percentage.
10,000 / 40,000 = 0.25
0.25 x 100 = 25%
In this example, the overhead rate is 25%, meaning that 25% of your total sales amount goes towards overhead costs. So, you would need to charge an additional 25% on top of materials and labor for a job to cover overhead expenses.
When calculating pricing for jobs, you can use this number to determine how much you need to charge in addition to the direct costs of a job to break even. From there, you can add in your profit margin to make sure your jobs not only cover your total costs but make you money.
Keep in mind that it’s normal for overhead costs to increase year-over-year. Adjusting your prices to reflect changes in your total costs is a healthy way to stay profitable.
Pro Tip: If you aren’t sure what your monthly expenses are, it’s time to start tracking them.
How can I reduce overhead?
After calculating your overhead costs, you might be surprised by how much they add up to each month. From cell phone bills and utility costs to office rent and supplies, it takes a lot to run a service business.
Here are some ways to reduce overhead so that you can either bring in a bigger profit or price more competitively.
1. Reduce your bills
Phone, internet, and software bills all make up a chunk of your overhead costs. You can try to reduce them by negotiating with service providers or even cutting out plans that you’re no longer using.
For example, if you are paying for monthly marketing software, but you only use it once a year, it may be time to look for a cheaper alternative or cancel the service altogether.
Another option is to look for software that offers more for less. Instead of paying separately for scheduling software, invoicing software, and a CRM, find a solution that offers it all in one.
READ MORE: Find out how this pest control company cut their software bill in half
The same goes for your internet and phone bills. Look for corporate rates, simpler service plans, and cancel any services or add-ons that aren’t necessary to run your business.
2. Downsize your office space
As a home service business, you do most of your work in your clients’ homes or at job sites. This means that you probably don’t need a big, fancy office to write up paperwork in. If possible, move your office to a smaller space or even opt to have office employees like dispatchers work remotely. This can save you a huge amount of money on overhead.
If you can’t downsize, consider negotiating rent costs with your landlord.
3. Hire contractors or part-time workers
Accounting, reception, and janitorial staff all count towards your overhead. But you may not need them to all work full-time. When possible, hire contractors or part-time workers for overhead-related roles to save on costs.
You can always bring on full-time staff down the road when your business is able to support them profitably.
4. Use business software wherever you can
Accounting, bookkeeping, and client management software can all help you to save on overhead costs. Instead of having to hire staff members to oversee booking appointments, facilitating payments, and sending invoices, you can use software to do it instead.
Monthly software subscriptions are often significantly cheaper than full- or part-time staff members and can take care of a lot of different tasks. And if you don’t have time to manage the software yourself, you can always hire a contractor or part-time worker to do it for you. It will probably still be significantly cheaper than having a full-time staff member or two.
5. Go paperless
Printing and mailing contracts, quotes, invoices, and receipts costs more than you think. Ink, paper, stamp, printer, and envelope costs all add up over time. Not to mention the cost and stress of losing any of those documents.
By going paperless and sending communications through email or text, you can save money, time, and keep track of an organized paper trail.
Plus, clients will appreciate how easy it is to work with you when they can approve contracts and pay online.
READ MORE: Learn how this arborist saved thousands of dollars by going paperless
6. Reduce your marketing costs
Marketing costs can have a significant impact on your overhead expenses, but they aren’t always successful.
Marketing is a tricky business. It often requires a lot of trial and error as well as experience. It’s important to scale marketing efforts thoughtfully and slowly so that you don’t pour too much time or money into an unsuccessful campaign or promotion.
Whenever possible, focus on low-cost initiatives, like word-of-mouth and referral marketing, and tearaway flyers. If you decide to try out a new marketing tool or platform, start small and only pursue the options that show promise.
7. Rent equipment
As a home service business, you probably use a variety of equipment to complete jobs. But there’s a difference between equipment you use on a regular basis versus equipment you only use on occasion. For equipment that you only need for very specific jobs, consider renting instead of buying.
Not only will this reduce overhead costs for vehicle payments and insurance, but maintenance and repair costs as well.
The same goes for vehicles. If it makes sense to lease instead of own when you’re first starting out, give it a shot.
8. Stay on top of costs
The best way to reduce your overhead is to stay on top of it. By understanding all of your costs it will be easier for you to see where you need to make changes. Plus, it helps you to keep a pulse on your business, indicating when and where you can improve in terms of expenses and pricing.
Knowing exactly what makes up your overhead and what you need to bring in each month is one of the best ways you can maintain your profitability as a home service business owner. Keep track of costs on a regular basis and scale slowly to grow your company from a startup to a steady small business.
Want to know more? Watch this episode of Ask a Business Mentor to hear four home service experts share their typical overhead costs—and tips on how to manage them: