Overhead and Profit: What it is and isn’t

In business, costs are broadly categorized into two main types: direct and indirect costs. Direct costs encompass expenses directly related to the physical aspect of a specific project, including labor, software, equipment, and material costs, etc.

Indirect costs, such as administrative costs, cover the managerial and operational costs associated with a project but cannot be directly tied to individual projects or tasks. Overhead is a type of indirect cost and should be accounted as such in your business financials. Essentially, every cost that is not related to a project and cannot be billed to a client as a specific line item, is an overhead cost.

Overhead costs are the less glamorous side of business management, yet they can directly influence your bottom line. General overhead expenses encompass a wide range of areas, including administrative costs and operating expenses (which may include costs such as salaries, utilities, marketing, insurance premiums, office rent, office equipment, and other office expenses). 

Overhead costs can be further broken down into fixed, variable, and semi-variable overhead. Fixed overhead is overhead costs that remain the same for a long period of time and do not fluctuate with the business, variable overhead is overhead costs that will fluctuate with the business activities and semi-variable overhead is overhead costs that are a mix of fixed and variable overhead where some costs are taken on no matter the businesses activities but may fluctuate as the business pursues growth and change.

When you are a small business, overhead is everything except for payroll, taxes, and benefits. But as you grow, the way you look at your people and overhead starts to morph. Once you pass the $1,000,000 mark, and definitely as you hit $2,000,000, you start to move some salaries out of people and put them in overhead. This is because you are becoming a more professionally run business. Here are the big four that get moved:

Marketing Salaries 

As you begin to bring marketing in-house it is time to start moving those salaries out of “people” and put them under marketing, a subset of overhead. These are full-time people whose only responsibilities are marketing. I’m not talking about the legal assistant or receptionist you have tasked with doing social media. These are dedicated marketing individuals with 100% of their time (and therefore their salary) going to marketing. The reason we want to move marketing salaries into overhead is so we can know the true ROI (Return on Investment) of ALL the money you spend on marketing, not just your PPC, SEO, and website expenses.

Administrative or Non-billable People

When your firm starts, employees wear numerous hats. The larger your firm becomes, the more people can shed hats and start doing just a single job. For example, you hire a paralegal who answers the phones, does paralegal work, and makes sure you have printer paper. Then you hire a receptionist who takes on the phones and office paper. This goes on until you start to see a true divide between those people who are doing billable work and those who are supporting the operations of the office and don’t contribute AT ALL to the legal work. When a position becomes 100% non-billable it is time to create a new section on your Profit and Loss Statement (P&L) under overhead called “Administrative Salaries”. Move all your non-billable payroll expenses (office manager, receptionist, bookkeeper) out of “people” and into “overhead. 

To better understand payroll, check out our article about how much to pay billable persons.

Sales and Intake 

Just like with your admin team, in the beginning, your paralegal is doing the filing, handling intake, answering the phone, AND doing billable work. Sales or Intake is a great example of a job that is done by multiple people in smaller firms. The owner does the sales call, the receptionist sends out the fee agreement, and the paralegal or office manager gets the new client set up in the practice management system. When you bring on a dedicated salesperson, they need to move out of “people” and into “overhead”. The biggest question is where they should sit in overhead. Do they go into that administrative bucket or are they a marketing cost? They are both valid locations and I am going to give you the classic attorney answer of, “It depends”. Neither is right and neither is wrong, there are many different ways to look at your overhead costs. It is a matter of personal preference and of how you think about your firm. What is important is that they get moved out of your people section.

You

Your job also evolves as your firm grows. Gone are the days when you spend every night and weekend doing all the billable work you haven’t been able to get to during the week. Now you have associates and paralegals doing it and you have turned your talents to areas of the firm where you are most valuable: usually sales, marketing, and planning strategic growth. In the book Traction, Gino Wickman calls these people “visionaries” because they are the ones who see the path forward and drive towards those goals. As you shed billable work and take on more visionary projects, you also need to migrate your salary towards the administrative salary bucket in “overhead”.

When people ask what is in overhead, there is a base answer and then the “it depends” answer.  The biggest question for you is this, “Where are you on the growth trajectory and is it time to acknowledge that not all people sit in the “People” part of the Rule of Thirds equation”?