The success of your business depends on your ability to sustain healthy cash flow. When boosting revenue is difficult or not possible, reducing fixed costs is a great way to improve profit margins.
Understanding your fixed costs
Businesses have to contend with two types of costs, fixed and variable. Fixed costs are also known as overhead or fixed expenses. As the name suggests, fixed costs refer to expenses that remain the same month to month. Unlike variable costs, fixed costs do not change when there is a change in sales volume or production volume.
These costs have to be paid even if the business is not making sales or profit. While being predictable, fixed costs feature on both the balance sheet and income statement. The common examples of fixed costs include:
- Utility bills
- Mortgage or lease/rent payments
- Equipment lease payment
- Phone service
- Internet/Wi-fi bills
- Public liability insurance
- Weekly payroll
For a manufacturing business, the fixed costs can include equipment maintenance, depreciation on equipment, business licenses, indirect labor, and insurance premiums. For a restaurant, the fixed costs include rental/mortgage payments, utilities, health permits/license renewals, and insurance.
Variable costs, on the other hand, are directly related to your business’s sales volume. When the sales volume goes up, the variable costs rise and when sales are down, these costs also go down. Examples of variable costs are the cost of
- raw materials
- Shipping and handling
- Supplier payments
- Social media advertising
9 ways to reduce overhead costs
Reducing your fixed costs is a proven way to ensure you have a healthy cash flow. Here are some ways to reduce your business’s fixed costs:
Calculate your overhead costs: Start by making a list of your business expenses and categorize them based on fixed and variable costs. Add the fixed or overhead costs and divide this number by your monthly sales. Multiply the result by 100 to get a percentage of your fixed costs. For instance, if the ratio is 15 percent, it indicates you spend $15 as fixed expenses per $100 of sales you make. It is important to watch the percentage on an ongoing basis. A declining ratio (or a higher percentage) is a sign of trouble and indicates that you need to take steps to reduce your overhead expenses.
Review your insurances. While public liability insurance protects your business and your employees from claims of negligence as a result of property damage, you can buy the most suitable one by comparing quotes from top insurers. This will help you get better coverage for a lower price.
Review your business space: Evaluate if your existing office space or building is giving you the return on your investment that you seek. Search for smaller office spaces if feasible or explore other locations that are not as expensive to reduce your rent, utilities, and travel expenses. You can also look at co-working spaces and shared office spaces that are a growing trend across New Zealand. While the number of such spaces grew phenomenally from 2013 to 2017, over the next five years, co-working spaces are expected to rise by 15 percent. The flexible pricing plans these spaces offer will help reduce your fixed costs.
Switch to public transport or lease. If you are using a big car, the running and maintenance costs can be high. Switching to smaller, more economical vehicles is an option as is using public transport. Operating leases offer several advantages while saving money. Leasing eliminates the need for investing upfront on buying a vehicle while the operating expenses are 100 percent tax deductible.
Leverage technology: Evaluate if you are leveraging available technology to the full extent. Video conferencing can help you save hundreds of dollars in travel expenses while digital document storage eliminates the need for physical storage space, printers, and scanners.
Evaluate labor costs: Hiring interns or entry-level employees can help you cut down on salary costs. Some companies have saved fixed expenses by offering four-day work weeks with a salary cut.
Negotiate: Chances are that your business may be paying too much for power, internet, equipment leases, and phones. Study your monthly costs and do your research on different providers before you schedule a discussion on costs. Negotiating with your energy company, your landlord, and the telecommunications providers can help arrive at the best deals, that in turn, lowers your overhead expenses. Shop around for cheaper options if your provider is not willing to lower rates.
Consult an accountant. It is a great idea to discuss your overheads with your accountant. They may be able to find deductions or ways to reduce your fixed costs that you may have overlooked or missed.
Look at cost-effective options: Think about how you can change your processes, design, and resources to reduce your overhead costs. For instance, a bigger fridge, extra workstations, or overseas conferences can impact our fixed costs in a big way. Get rid of unnecessary travel and items that are cranking up your energy bill.
From negotiating with providers to exploring co-working spaces, there are many ways your business can reduce fixed expenses. A careful evaluation of your current overhead costs will help you prioritize your investment.
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