Use Overhead Rates to Stop Surprises

Overhead rates have historically been used to improve the estimating process at mid-sized companies. However, I think it’s also a very useful tool in the world of startups and
small business.

I’m often asked by business owners, “In my mind, we should be making about X amount with every sale. With our lean expense budget, I think we should be making more money. Where am I off?â€

Rather than having to stop and crunch situation specific numbers, every time it’s asked, I’ve taken to training business owners into a different way of thinking. I’d like my CEOs and their estimators to use overhead rates in the estimating process AND in their thinking process. For every dollar of cost they carry in their heads, I’d like them to think about a relational amount of overhead to get a real grasp on how much money the CEO thinks he’s making per sale.

Simply put, overhead rates are the total of all of your indirect costs (all costs not allocated to direct cost of sales) divided by a meaningful unit that you often use for estimating – like direct labor cost or hours. If you apply an overhead rate to your cost of labor when you are quoting new customers, you will minimize surprises down the road by including an allowance for overhead in your pricing.

However, overhead rates are not very popular with startups because when a company is losing money as they invest into the platform they will need to grow from, they cannot fully burden their pricing to cover overhead and still keep customers.

Never fear! Just because you are not there today, doesn’t mean that you can’t look at potential overhead rates as you assemble your forecasts and projections. In my opinion, that is the best time to begin looking at your overhead rates because the insight into pricing now can help you achieve your goals more quickly.

An overhead rate isn’t just a great pricing tool and a better way to think about pricing, it can also be a worthy milestone.