BACKGROUND
We are currently going through a series of blogs on the types of statements which are more relevant to planning than the traditional financial statements (income statement, balance sheet, cash flow). In the past, we looked at the Revenue Statement and the Operations Statement. In this blog, we will look at another one of the documents to use in their place—the Overhead Statement.
The purpose of the Overhead Statement is to provide a strategic framework for understanding corporate overhead. “Overhead” consists of those activities NOT directly related to producing or marketing/selling what you sell. These are already covered in the operation and revenue statements (mentioned in earlier blogs).
Yes, the income statement also has lines describing various
costs related to overhead. However, the income statement doesn’t tell you why
these numbers were chosen and what the strategies are to reach these numbers. That’s
why I designed the Overhead Statement.
Since there are so many different types of business models
out there, the overhead statement would need to be tweaked a bit to fit each
type of industry. But a rough example can be seen in the figure below.
1) The Baseline
The first part of the Overhead Statement is used to
determine the baseline. This is what overhead costs would be if nothing changed
and there were no new strategic initiatives.
As a result, the baseline is more or less a continuation of
what you have done in the past.
2) Strategic
Changes to Overhead
Over time, one’s overhead structure can become outdated.
This could be due to internal factors like a change in the company’s business
portfolio. Or it could be due to external factors, like new technologies or new
approaches to management. Either way, change is change, and if you don’t
change, your overhead will not be as efficient or as effective as it could be.
Strategies will be needed to determine how best to change
and adapt the overhead. That is why the
second part of the Overhead Statement looks at the impact of strategic goals on
operations.
a) Cost Control
(Becoming More Efficient): One of the simplest strategic goals is to reduce
the cost of overhead. If that is a goal, then you would place here what the
cost control strategy is and how much you expect it to lower overhead expenses
(by individual overhead line). Some of these cost reductions may require
up-front capital investments. This amount gets transferred to the Investment
Statement (which we will talk about in a later blog). If you plan on using the
cost reductions to support price reductions, then those price reductions would
be reflected on the Revenue Statement.
b) Management
Improvement (Becoming More Effective): There are lots of ways to improve
the effectiveness of one’s overhead. This might include delayering (or adding
layers). Or it could be a major reorganization. Or it could be technology and
system improvements. Or maybe it includes outsourcing a function. Whatever the
strategy to improve overhead effectiveness, it needs to be captured. In this
section, one would explain what the strategy is and how it impacts the
overhead. Then, the incremental overhead costs associated with each strategy
would be calculated and listed by line item.
If there are any ripple effects from these changes to
overhead that would impact sales or operations, those changes would be
transferred to the revenue and operations statements. This is highly likely,
since one would typically not change overhead unless it improved these other
areas. Similarly, if the changes to overhead required major capital
investments, you would want to transfer that cost to the investment statement.
c) Compliance:
Sometimes, you just have to change the way you do things in order to remain
compliant with the ever-changing regulatory environment. You would capture the
overhead impacts from that here as well.
3) Net Results
The third and final section looks at the net impact of the
first two sections on overhead expenses. Basically, you take the baseline overhead
expenses (by line) and add to it changes from cost reductions, management
improvement, and compliance. The end result is your estimated costs per overhead
line item for baseline PLUS changes.
The benefits from using an Overhead Statement are as follows:
- It proactively links all
of your strategies to specific overhead activities.
- It quantifies how the
implementation of each strategy will impact the costs of overhead.
- It separates all of the
components of strategy, so that you can critique each one for
reasonableness.
- It separates overhead
issues to its own document, making it easier for those in charge of overhead
to see what they are being held responsible for.
- It forces one to consider
issues beyond cost control when looking at changes to overhead.
To more comprehensively understand the operations portion of a strategic plan, it is recommended that some form of an Overhead Statement be used. An Overhead Statement has three sections:
- Calculation of Baseline Overhead
- Calculating Impact of Strategic
Initiatives on Overhead
- Net Results
Overhead might not be the most exciting part of the business, but it is an important part of the business. A little bit of strategic effort in this
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