There’s a misconception in the industry that major operating costs (a.k.a., overhead) create financial strain, and if businesses start cost-cutting, they can hit profitability.
Cutting overhead is a good practice if expenses have become inflated due to lack of management of those expenses.
But as overhead should account for less than 15% of revenue, cutting these costs is generally not enough to boost profitability and cutting too deeply has consequences:
It can deprive your business of what it needs to produce value for your customers and allow you to charge a premium.
We’ve yet to see anyone go out of business due to overspending on fixed or variable costs. Instead, most businesses fail for one of these four reasons:
- Not properly managing their gross margin. This is the most controllable lever (and biggest miss for dealers) in the business.
- Payroll. We recommend having a 30% wedge between gross margin and payroll to ensure you see a double-digit profit. If you are in a situation where you have more work that needs to get done, but profitability and cash are a concern, it goes back to poor margins.
- Poor cash flow. It is critical to understand how much money in the bank is yours, how much is committed to projects, and how much is necessary to maintain healthy business operations.
- Poor work. Not doing great work and having to overspend on marketing to get that next job, then dealing with the ebbs and flows of job timing can lead to disaster.
If you are spending more than 15% of revenue on fixed and variable costs, here are some tips to rein in your overhead spending:
- Diligently manage all expenses as they incur, including cash outlay on things you can control, like leases, fuel, vehicle maintenance.
- Simplify how you categorize and review expenses. (We suggest 3 main overhead buckets, with sub-accounts as needed: admin, occupancy, and sales.)
- Review and compare benchmarks monthly.
- Implement simple metrics to change as you grow.
Don’t let market concerns make you believe that better outcomes aren’t possible. You just have to push the right levers.
The VITAL method is the best way we know to do these things without adding tasks to your to-do list. If you would like to dive deeper into managing major operating costs, watch the replay of our CI Business Mastery class here.
Matt & the team