How to do overhead value analysis for a small business
QUESTION: My small business is breaking even, actually, we are losing a little bit of money. We’re making a good gross margin for our industry, but I think our overhead has gotten out of control. I’m sure I need to cut cost, but I’m not sure where or how much. Can you help?
ANSWER: It does sound like you need to reduce overhead costs. On the other hand, you are right to avoid indiscriminate cost reductions. Cutting in the wrong places could do irreparable harm to your company. Over the years, we have seen numerous small businesses reduce their overhead costs safely.
We recommend a process called Overhead Value Analysis. The intent of this work is to identify savings in the company’s overhead costs. You could conceivably do this work yourself, but we have found that there is significant value to having it done by an unbiased third party. The steps are as follows:
People are also reading…
1. Get an overview of the operation – A third party will begin by meeting with the owner and perhaps some of his/her key lieutenants to get a clear picture of how the organization runs and the key responsibilities of each department. This always involves getting an organization chart (which may have to be created). The goal of this step in the process is to gain a very clear understanding of how the senior people think the organization runs (caution, the understanding of senior people, even in a small company, does not always match reality).
2. Identify the tasks and the time people are spending on each – The third party should then meet individually with each employee, or at least a reasonable sample of the employees, to ask how they spend their time. Have them layout exactly what tasks they do. Then ask how long it takes to do each task. When the estimates don’t pass the sniff test, push harder, asking penetrating questions and requesting to see work products. You want the estimates to be as accurate as possible. Watch out for people who inflate the time it takes to do their work. Amazingly, after the math is done, it often turns out that the sum of the time people spend doing their tasks is significantly less than the number of hours for which they are paid.
3. Determine the number of hours it should take to do each task – You have already identified the time that people said they spent doing each task. Now you need to determine how much time it should take them. Do this by cross checking the estimates from other employees that perform the same task. It may be necessary to get two individuals together to resolve any significant differences. Meet with supervisors and senior managers to get their assessments. Ultimately, settle on an estimate of how long it should take to complete each task.
4. Identify opportunities – You will find opportunities to reduce overhead in three areas:
- Tasks that do not need to be done – You may identify tasks that are redundant or for some other reason do not need to be done. Obviously, eliminate such tasks and save the time required to complete them.
- People who are underutilized – You now have the best estimate you can attain of how long each task should take. Do the math and determine the number of hours needed to complete the tasks of each department versus the number of hours that are available and identify areas of underutilization.
- Work that could be done by a less costly resource – You will likely find that highly compensated people are spending significant amounts of time doing things that could be delegated to less expensive resources.
5. Finalize the action steps and calculate the benefit – Now the hard reality—you have identified many possible savings opportunities. However, capturing real savings requires a reduction in:
- The number of employees
- The average compensation per employee
- Money paid to third parties
Sometimes companies can achieve savings by not filling vacancies or by delaying hiring as the business grows. More often, the owner faces difficult, gut wrenching decisions. But, if the company is going to save money and become profitable, difficult choices must often be made.
Overhead Value Analysis is a powerful tool for reducing waste and increasing profitability. Capturing the benefit most often requires tough decisions, but in some cases, this is the best alternative.
Doug and Polly White have an ownership stake in Gather, a company that designs and operates collaborative workspaces. Polly’s focus is on human resources and people management. Doug’s areas of expertise are business strategy, operations and finance.
