Once you move the shop out of your garage and rent space, you have overhead. If you hire people to work for you, you have overhead. And, as soon as you get a subcontractor to do anything for you – deliver a cabinet, spray a coat of paint on a vanity or whatever – you have overhead.
What exactly is this overhead? At the most basic level, it’s anything that you, as a business, have to pay out above and beyond the “cost of goods sold,” as our accountant friends would say.
What you pay Alison per hour for the privilege of working for you is a direct cost. What you pay for her dental benefits is overhead. What you pay your hardwood supplier for that unit of alder that just landed at your back door this morning is a direct cost. The costs you incur actually processing the supplier’s invoice – Lisa entering it on the computer, the time it takes for Jason to approve and then sign the check – that, too, is overhead.
The cost of overhead for small- to medium-sized shops can vary widely, but typically you will incur, at a minimum, between one-quarter and one-third of your costs in overhead. This means that for each $10,000 of cost, at least $2,500 will go toward indirect costs of running the business. This is a chunk of change! What’s more, if you can shave costs here, the dollars will go to the bottom line, right into your bank account.
While it’s kind of basic, it’s critical to know what overhead is costing you. If you have a bookkeeper, that person should set you up with a basic accounting system to record not only the direct costs of the business – your lumber and hardware purchases, your payroll costs – but also the indirect costs, as well.
A list of those expenses by category – the rent, utility bill, health insurance, travel, vehicle repairs, gas costs, marketing, etc. – will enable you to see what you need to add to your estimating to really cover the cost of doing business. It may surprise you to find that you must triple the hourly cost of an employee in order to pay for one hour of shop time. You also might want to sit down with an accountant a couple of times a year to review that itemized list, and the direct effect it has on your annual sales and profit. If your accounting software program can do it, it may also be a good idea to produce a monthly graph of what’s happening. For instance, you may want to ask yourself whether your indirect costs are trending up or down. This may help you figure out which areas of indirect cost need your attention.
Usually the key to being financially healthy is to stay as lean as you possibly can. The idea is to keep those recurring monthly expenses down as low as you possibly can!
You can divide the indirect costs of running a business into two basic categories – fixed costs and variable costs. You may want to carefully track and split the overhead list into those two sections so you get a handle on what’s what.
While there are some fine lines between the two categories, in general, the fixed expenses are harder to control than the variable ones. It’s tougher, for example, to change the amount of monthly rent you pay the landlord than what you spend on advertising for your shop in the local newspaper. However, if you’re noticing rents going down in your neighborhood, there’s nothing to say you can’t change the deal and renegotiate your own lease. Your on-going office and admini-strative expenses will usually be fairly even, but have you considered a part-time office manager? Bear in mind that both voice mail and e-mail can handle a lot of customer contact these days, and are much more accepted than they were even a few years ago. And, perhaps you should consider completely outsourcing the bookkeeping function, along with a payroll service to process your paychecks.
Another ongoing fixed expense would be a lease cost – if that’s the way you do it – of big equipment. It’s often good to spread the cost of the new edgebander, for example, over a three-year time period and pay as you go.This monthly expense is steady, and will be around unless you decide to pay it off early (and you may also save some interest cost there, as well).
One recurring expense is depreciation; even though it doesn’t actually cost you money, your tools and equipment are wearing out. Therefore, it’s good to think of this cost as wear and tear. After all, you’ll probably have to replace some equipment after five years. Some shop owners even try to salt away some of the depreciation amount into a bank account for exactly that purpose. You can always expect that it will be necessary to buy new tools down the road.
When it comes to variable expenses, you may have more latitude in controlling your costs. Variable expenses are ones that don’t necessarily appear every month, but do happen. The cost of tool repair or blade sharpening can vary depending on use, and these costs rise and fall depending on how busy things are on the shop floor. If you’re successful at communicating just how careful your employees need to be with shop equipment and hand tools, you may be able to keep these costs in check. Bring it up in your safety meetings with the crew!
Marketing is one of those variable expenses that can fluctuate. Many shops spend between 1% and 2% of their annual sales on ways to keep their name out there – through advertising, mailers, open houses, ball game tickets, whatever. Here you can trim back when needed, but bear in mind that, when things are slow, the marketing should probably be the last place to cut costs.
Training your people is another area of indirect expense that does not have an immediate effect on your business. However, having two employees who can run the shaper can allow you to be more flexible with your team. The same goes for new software, in the shop or in the office. Remember, a little cross-training can go a long way.
The key in all of this is really knowing and understanding where your hidden costs are. It’s relatively straightforward to know how much a particular job should cost with regard to labor and materials. It’s harder to know what to charge for the whole thing. Only by keeping track of your hidden costs will you be able to price the work properly and come out with all of your costs covered.