Remember: Overhead Eats Your Profits

Frugal does not mean cheap

When we buy something cheap, we hope we are getting a bargain, but what we usually get is something of inferior quality. Being frugal is something different altogether—a careful management of resources is characteristic of a thriving, prosperous business.

Below are two examples of overhead expenses growing small to mid-sized businesses often make.

1. Office Space - How luxurious does your office space need to be? That $20,000 marble table certainly looks impressive in your conference room—will it help land that whale of a client? Or would a simple wood table do the trick? Is it not frugal to decorate your office to reflect the economic status of the clients you would like to attract?

2. Company Cars - Does your small business need a fleet of Range Rovers for your salesman so that they can make a favorable impression on your clients? Will your salesman driving an import actually be a deterrence to your potential client? Judge your cars to reflect the expectations of your clients. [As a side note, there are tax advantages to having company cars of a certain size.]

Remember: Overhead eats your profits

Let’s take a look at how Toyota recently made an overhead decision:

In 2017, Toyota opened a new centralized office complex in Plano, Texas, combining under one roof its California, Kentucky, and New York offices, as well as its financial services. As a resident of North Texas, I was thrilled at the prospect of this boon to our local economy. The construction of Toyota’s new headquarters along with the transfer of the thousands of employees from across the country to our area was a big deal. I have been lucky enough to tour the facility on a couple of occasions—and it does not disappoint. Employing approximately 5,000 employees at the facility, Toyota purposefully incorporated North Texas features in its design and landscaping with the use of limestone and native Texas plants, including the careful preservation of hundred-year old oak trees that called the land home before Toyota. There are numerous restaurants, a gym, and a pharmacy. It is truly impressive. At a cost estimated at approximately $1 billion, this was a massive investment by Toyota. And it was not taken lightly by Toyota executives, but rather was a calculated plan to improve profitability by changing the company’s culture, to merge employees scattered across the country. Every feature of the complex—from a rock climbing wall to a hanging traffic light--is designed to improve the communication among Toyota’s employees.

Toyota, obviously a multi-billion dollar corporation, did not view the expense of consolidation as a waste of overhead. Rather, it spent years planning the consolidation with the purpose of improving its culture—all for the end goal of improving customer experience to maintain and grow its revenue. Every cost was considered and analyzed.

Admittedly the magnitude of expenses that make Toyota profitable are probably quite different from those that make a small business profitable—but the amount of time and effort expended on analyzing overhead expenses and their goals should be no different!

All business requires overhead expenses. You have to have an office, administrative supplies, phones, copiers, a storage facility, insurance, accountants, and even lawyers. When I am looking through the financials of a distressed business seeking ways to protect equity and cash flow, I look at overhead expenses and ask the business owner how many dollars of revenue are created from those expenses.

Here is a recent example I encountered. A business owner experiencing cash flow problems called me in to help with his credit lines. His revenue was actually quite good, so he should have been able to cash flow his credit lines without any problem. Visiting his office, I realized that 50% of the office space was empty. I asked him why he rented so much office space. (Note: There are actually times when taking on significant extra space makes sense). His response, quite typical, was that based on his forecast, he expected to double in size from an employee stand point within the year, thus needing the extra office space. But unfortunately, his line of credit was not based on his forecast but was based on his immediate revenue. Together we identified a variety of other corresponding overhead costs that were similar in nature. One-by-one his expenses were analyzed and dealt with in a “frugal” manner. A negotiation with the landlord resulted in an option to account for future growth while cutting current rent costs by nearly 50%. This helped aid in renegotiations with the bank on extending the line of credit and resulted in a reduction of other overhead costs.

Many of my clients tell me that they have to look the part if they are going to get the customers they want. So they go for the posh office, and the flashy car lease. I agree with the need to provide a sense of security and quality to clients. And I think this means something different in every industry. Putting all of your salesman in Range Rovers instead of a more moderately priced vehicle that creates the same tax incentives is not one of them. There is a balance that has to be reached.

Here’s the caveat however: Making all investment and purchase criteria based solely on cost is also the wrong answer. Pure cost decision-making results in an appearance of being cheap, the opposite of appearing prosperous through thrift, through careful management.

Being frugal with your expenditures means doing the necessary research to determine how each dollar can be maximized to purchase the tools that will cause those spent dollars to directly increase revenue. Splurging on a marble conference room table when your clients are lower- to middle-market is not something that will increase their sense of security and confidence in your business or lead to growth in your business. A clean respectable office space finished with quality, but not excessive, furnishings will.

So what are good expenditures? An example is investing in a talented administrative staff is a good expense. Efficient staff results in a fewer number of employees who can handle the pace and work load. And this provides better overall service to your client.

Here is a brief bullet point checklist of line item expenditures I initially look at when looking at a distressed company.

Line Item Expenditures Checklist:

Rent
Staff (Is every staff member fully employed?)
Vehicles for salesman including fuel reimbursement expenses
Copier leases and computer leases
Meal reimbursements for in office meals
Office supply purchases
Office furniture leases

It is surprising how much can be cut routinely from the above list. I would suggest that every business do an analysis of these expenditures at the end of every year.

Resources are finite—spend thoughtfully!