How to Calculate Your Overhead

Knock-knock.

Who’s there?

Overhead.

Overhead…who?

EXACTLY.

Joke didn’t land? That’s OK. Overhead is no laughing matter. It’s popped up in the background of many shop operation articles, and most shop owners are at least vaguely aware that a lot of their monthly bills go towards overhead…but what is it, exactly? How do you determine it?

And how can you reduce it?

We set out to answer these questions and more. To help us out, we spoke with Irvin Bowman of Truck Shop Network, Robert “Robby” Gilbert, Fullbay’s Director of Finance, and Scott Wheeler, President of Automotive Consultants Group. They sat down with us (well, virtually) to chat about all things overhead and help us break down this often mysterious portion of operational expenses. 

WHAT IS OVERHEAD?

Let’s start out by describing what overhead is, especially in the context of this article.

“If you’re not selling it, it’s overhead,” Irvin says.

“Overhead is things that don’t directly contribute to generating your product or service,” Robby confirms.

So, if it’s not a profit producer or revenue generator, it’s likely overhead.

• A technician produces profit through their labor. A technician is not part of your overhead.
• Your accountant, if you have one, does not produce profit through their labor. It’s a true cost…but you generally need them to help run your business. They are part of your overhead.

In other words, your overhead consists of bills you’ll have to pay even if no money is coming in. As a general rule of thumb, Scott suggests that your operating expenses (including overhead) should not account to more than 25-30% of gross sales.

Generally speaking, the lower your overhead, the more efficient your operation. A one-man mobile repair tech will probably have way lower overhead than a five-acre facility with seven bays.

WHAT COUNTS AS OVERHEAD?

Okay, you’re now probably looking for a list of what is or isn’t overhead, right?

Well, it isn’t quite that easy…

First, make a list of all your expenses. Look at them fondly. Then go down that list and check off the ones that directly drive revenue.

Anything that doesn’t directly drive revenue counts as overhead.

Here are some examples:

Overhead

• Wages for front-of-house staff (service advisors, parts guys, management, etc)
• Lease rates/mortgage/general real estate fees
  • This includes things like property taxes (if you own the building/land), property insurance, and so on
• Utilities (you kinda need lights, even if they aren’t performing repairs)
• Supplies
• Advertising and marketing expenses

Not Overhead

• Your back-of-shop staff (technicians!)
• A high-dollar piece of equipment (like a lift or alignment machine; these should be written off as one-time investments)
• Parts! Especially these days

Then there’s other costs that can go either way (depending on how you view and use them). “Make a judgment call,” Robby says.

Let’s take service trucks. They can count as overhead because they have static costs associated with them (like fuel, insurance, possibly payments), but they can also be out there earning you money like a gigantic gas-guzzling technician.

Take a close look at all of your finances. Like Robby says, some items will be judgment calls. But once you’ve got them in order, you can move on to the next step.

HOW TO CALCULATE YOUR OVERHEAD

How you actually calculate your overhead will depend on how detailed your records are. Irvin describes figuring out overhead as “a math problem that needs to be solved,” which will either put you at ease (yay math!) or give you hives (ARGH! math!).

So, round up all the records you have around your overhead. If you’re a newer shop, this won’t take a lot of time. If you’ve been around for a while, going back a few years will help you with future projections. But let’s say you have 12 months worth of records. Add them, and divide them by 12.

That’s your average monthly overhead.

There’s more to do after grabbing that number, but we do want to high-five you real fast. Just looking into your overhead puts you ahead of a lot of other shops—many of which don’t have the time or energy to really zero in on what they’re paying to exist. They get caught up in the day-to-day running of the shop and glance at their accounts and say, “OK, we’ve got enough to keep going.”

But that’s not an actual reflection of how healthy the business is, or where they need to be priced in the market because they don’t know what the actual cost of running the operation is. That’s how you wind up with situations where shop owners just pump everything they earn back into the shop.

But that’s not going to be you!

HOW DO YOU REDUCE YOUR OVERHEAD?

So, now you know your overhead. Maybe you’re happy to leave it there; knowledge is power and all that. But maybe you’re looking at inflation and the economy and wondering if you can trim things.

When it comes to decreasing expenses, Scott reminds us, “If you reduce your operating expenses [including your overheard] by $1, that $1 drops immediately to the net operating profit.” 

Important, right? Especially when so many shops are so frequently working on such razor-thin margins. Every dollar that goes back into profit is a minor victory.

But with that in mind, let’s make it clear that you can’t reduce your overhead to nothing. You are always going to have some kind of operating expenses. Looking for places to reduce them is a start, but it’s going to vary by shop. “It’s a case by case basis,” Robby says. “You’ve got to look at all of the costs contributing to overhead, and see where you are and where you can cut back.” 

Let’s return to Irvin and his Shop Math.

First, look back at (once again) the prior 12 months and see how many hours you’ve invoiced. How many hours have actually been billed out to customers on work you’ve performed in the shop?

Divide your total overhead by that number.

The resulting number is the way you combat your overhead.

In Irvin’s experience, that resulting number is often higher than a shop’s labor rate. For a lot of shops, the only way they’re making up the difference is what they’re charging for parts.

Once you understand your overhead costs per hour, you can understand what your gross profit per hour needs to be for your operation to make it. If your market won’t bear a high enough rate to get your gross profit up, you’re going to have to find a way to reduce your overhead.

Here are three things you can try:

• Reduce overhead: This, says Irvin, is the hardest one to pull off, because you have to determine what you need or what you don’t. Sometimes the decision is easier than you think; you might have a tool or subscription that was useful in the past, but that you’re still paying for despite no longer using it. Some things you can reduce through research—for example, is there a less expensive dumpster company you can use?

• Charge properly: More money, more problems, right? Well, no, not really. Charging what you should for your techs’ work (or charging for diag work, if you aren’t already) means more revenue to cover your overhead. Just remember to stay within what your market can bear.

• Outrun your overhead: Otherwise known as Sell, sell, sell! If you’re running $100,000 a month or $200,000 a month, your overhead doesn’t change significantly. Pushing more sales through your shop gives you the opportunity to outrun your overhead.

In a perfect world, you might do a little of all three. But here in the real world, the third option is almost always the most practical choice.

GETTING AHEAD OF THE OVERHEAD

There are other things you can do to battle your overhead. Just about everyone we’ve talked to has agreed that efficiency is key. The way your shop is organized, and how it operates, will contribute to your bottom line.

Something else you can do to bolster your revenue: Invoice on time. This remains a huge problem for many shops. “If there’s a truck leaving your shop and there’s not an invoice going with it, you need to address that,” Irvin says. It is really hard to overcome not invoicing things out. You’re basically not getting paid for the work that you do and your daily, weekly, and monthly cash flow will suffer when it takes you months to invoice your customers!

(Fullbay makes it really easy to invoice—just sayin’.)

You can also make sure parts are accounted for. If you can’t bring up your labor rates any further, then you’ll need to make bank on parts, so to speak, and that means not letting any of them just walk out of the shop.

Many of our “shop operations” articles keep zeroing in on the same theme: To run a successful business, you need to treat it like a business. A lot of shop owners run into problems with this because they started out as technicians. They know how to fix things, and they want to fix things.

So when they open up their shops, it turns into a kind of “death by a thousand cuts,” as Irvin describes it, because there are so many little operational things that need to be taken care of, and they don’t know where to start.

So. Educate yourself. Treat your business like a business and understand the daily costs that go into operation. And above all, keep accurate financials! Review them on a regular basis. If you don’t have accurate financials, you don’t know where you’re headed. “It’s like driving with a dirty window,” Irvin says. “You can take a guess, but you never know when you’re going to hit a tree.”

Don’t hit the tree. Figure out your overhead—and point your shop in the right direction.