By Lee Schuh
Many businesses consider overhead to be the No. 1 impediment to reaching their business goals. However, it isn’t overhead that is the problem but rather the results of poor planning for the future growth of the business. This is certainly true for companies growing relatively fast.
We will use the term overhead not in the accounting sense but as covering all indirect costs of the business. Overhead too often increases faster than sales and profits, which can result in decreased profits and cash flow issues. This problem is due to a poor financial plan or a plan that isn’t followed. Sales grow faster than projected and require more cash and capital to meet the needs related to the increase.
Managers need to control four basic issues to bring overheard down to a reasonable amount. They are cash flow, the cost of items used for expansion, tradeoffs and monitoring. If performed properly, these elements become an integrated tool for successful control of overhead. These topics are updated and documented in the business plan or continuity plan for those who consider business plans passe.
Cash flow is king. Without cash you are bankrupt so managers must focus on maintaining a positive cash flow. The cash needs should be monitored continuously and matched against your financial plan. Deviations requiring more cash than planned cause trouble. Cash flow control is usually covered by an entrepreneur’s investment, a line of credit, sale of qualified small business stock or outside investors. Leasing capital equipment is a good way of reducing cash flow needs. Remember that obtaining a loan in advance is easier and less expensive than emergency loans. This financing of the cash should be included in the financial section of the business plan.
Spending beyond the direct cost of goods and labor is usually done to promote growth and be competitive. As a general rule, if you are spending to compete or you have a weakness that affects your sales you need to fix it. Generally, the faster a business grows, the faster funds are spent. Spending more than planned to meet the needs of projected growth can result in expenditures for capital items or inventory in excess of current needs. If the growth in sales is slower than projected in the business plan, there are no funds to cover the costs being incurred. It is better to stick to the planned growth rate than to exceed it or to fail to meet the sales objectives. Many entrepreneurs want to grow as quickly as possible but they can go bankrupt or run out of cash.
Tradeoff is a catchall term for a number of company objectives. Businesspeople know they can’t do everything they want, thus there are tradeoffs. The goal should be to pick those consistent with your business plan. If the tradeoffs selected are not consistent with the business plan, the marketing and financial sections need to be changed so that there is a source of funds to cover the items now deemed critical. Base decisions on needs rather than desires to avoid causing turbulence in the business plan.
Monitoring refers to the business plan. Businesspeople must take steps to ensure that the current marketing and financial sections reflect the goals of the business plan.
With computers, these updates can be made daily if necessary although weekly is more reasonable.
By controlling the growth and keeping it consistent with the living business plan, one can avoid the dangers of unanticipated cash flow problems caused by runaway overhead growth. Remember the classic saying: A bird in the hand is worth two in the bush.
• Lee Schuh is a lecturer in the California Lutheran University School of Management.