How Much Should You Spend on Overhead?
Dec 19, 2023
What is overhead? Which expenses are considered overhead and what is the difference with operating ones? How do these costs behave in a multi-unit franchise organization? In this blog post, we’ll answer these and some other questions around overhead.
Overhead is one of those accounting concepts that has different names depending on who you ask. It may be called G&A when it comes to general and administrative expenses, but you can also call it just administrative expenses.
- What overhead really implies is all those expenses are not directly related to the day-to-day operations of a specific unit in your franchise enterprise.
For example: your salary as a franchisee, because even if you don’t run shifts in a unit, you still receive your payment and this is not directly related to the daily operations of your franchises.
Something else that could be overhead is office supplies. But not the ones needed for the units, like staples, paper, or clips. If you have an office at home, all your supplies expenditure would be overhead.
This applies also to services. For example, if you pay a bookkeeper to do the books for your company, or an accountant that does your finances for your entire organization, their salary would go in overhead. The same for when you hire a handyman to do a specific project for a month, that would be overhead. But, if they do a maintenance job for a particular store, then the cost will be assigned to that particular store.
Let's say you are a multi-unit franchisee and have a district manager. That would also be considered overhead because, again, they're not attached to one particular unit's daily operations. They're overseeing a district, so this is an overhead expense.
4 Considerations about overhead expenses
- Separating the overhead costs doesn't mean that these expenses are not going to be charged back into the units. It just means that when you do accounting, you have to put them all together and then divide that sum among your total stores, because you have to spend money on these expenses to be able to manage your units.
Don’t miss: 6 key financial insights for multi-unit franchisees
- How the administrative cost is distributed is your decision. You can either divide it equally among your total units or do it based on sales. This would mean that the high-volume stores would have to pay a little bit more because they need more overhead expenses to support the operations.
- Another thing you need to consider is that whatever you spend on this overhead is going to come from the cash flow of your unit, so you have to be very careful with the money to prevent you from spending the entire profit of your organization.
- Don’t spend too much on your overhead especially if you don’t have the units built to support that expense.
When I worked for a global brand, I had an international assignment in Argentina to support a master franchisee. One of the things that raised a big red flag to me was that even though they only had four units open at that time, they had a very large office, with secretaries, bookkeepers, and a three-people training team.
Their amount of overhead was enormous considering the few units they managed and that they didn’t have an aggressive opening plan or any pending stores when I was there. So, on the one hand, they were spending a whole lot of money in overhead but, on the other, they were not operating or bringing in enough units to support or justify that amount.
Needless to say, that franchise eventually closed down because they overspent their capital. And that's the mistake that you must avoid.
5. Especially when you start to grow your multi-unit enterprise, you have to use external resources as much as you can. For example, instead of having a full-time employee do the payroll, you should hire an external company to take care of this task for you. That way, you’ll minimize the cost of your overhead.
How much to spend on overhead?
The general guide suggests that overhead should be 5% of your total revenue. This means that you take all the revenue for all your units and multiply it by 5%. That should be the budget you should spend on overhead.
Take this as a baseline because this guide assumes that each of your units is making more than 5% net profit and you have enough cash flow to spend on overhead. But if you are having management issues and cannot spend 5%, that percentage should be reduced.
Another thing you should consider is your maturity level. If your franchise business has already grown and is not currently under an aggressive opening plan, then you may need to be in between 3% and 4% because you are a stable organization.
- 5% is the average for an organization that is growing slowly but surely. And you want to have the support to be able to do that growth.
But, if you are in growth mode, then you’ll probably be around 7%, 8%, or even 10% of your net sales rate because you will bring more people into your company to support those plans. And remember, all of that money comes from your organization’s cash flow.
If you would like to know more about how to manage and minimize your overhead so you can maximize your profitability, explore some of our educational programs here at the American Franchise Academy!
Our programs are designed to give franchise leaders the knowledge, tools, and resources they need to be successful.
- Click here to discover how we can help you build your overhead, have structure, and make your business more profitable.
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Reflections:
- Can you clearly separate your overhead expenses from the operation ones?
- How are you distributing the administrative cost among your units?
- Do you have the capital to support your overhead costs?
- Are you meeting your growth goals to justify having an elevated overhead?
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