Stepping up the costs

by Adina Luca, January 29, 2018

As usual, we’re talking here about small businesses in professional services, because we like to help them grow and thrive. Their usual pattern is to start life in the entrepreneur’s own home, then move out to an office, and then to a bigger office. Every step up increases the cost base. So when is a good time to take on the greater risks that come with higher costs, and when is a good time to stay put where you are? Or even to go back to a lower step and start on the growth path again?

More specifically, we’ll be looking at office costs as a percentage of your total turnover.

Fixed costs go up in steps
Your fixed costs, of course, come from your office and administrative infrastructure – think of them as the price of having somewhere to operate from. As any finance book will tell you, you can grow your business with the same fixed costs up to a point. That point is usually a level of turnover which you won’t be able to improve on without employing more people, outsourcing more work, or investing in assets. And when you expand, it usually means a change of office premises, because you need more space for your new level of activity.

At that point you’ll find that your fixed costs all of a sudden take a ‘step up’. The challenge is that, beyond that point, there’s no way back: you’ll need to maintain or increase your turnover to cover the cost of the new infrastructure and make some profit.

That ‘step up’ can be clearly seen if you look at the changes in the percentages of your office costs: when they go up or down, they indicate whether you are ready for a step up or a step down.

What’s in a percentage?
Below are the categories of costs we include when referring to office costs. We’re thinking of them not as an absolute number but as a percentage of annual turnover.

  • Rent
  • Rates (or utilities)
  • Telecommunications (fixed and mobile), internet and broadband that cannot be linked directly to the delivery of services
  • Stationery and office supplies that cannot be linked directly to delivery of services
  • Office cleaning and similar
  • Office staff salaries, usually receptionist / PA, if any
  • Office transport and courier bills, if used for internal office purposes
  • Accounting, legal fees and other consulting costs
  • Internal protocol – food and drinks that are staff-related, not client-related
  • Depreciation of fixed assets that cannot be linked directly to delivery of services

Quite a few things go into that percentage. And below, as we go through the different steps in your growth journey, you’ll see how difficult it is to keep that percentage under control.

Step 1: setting up your home office
When working from home you should expect to pay about 3% of your turnover in office costs. A higher percentage would suggest your turnover is too low, or that you’re overspending on equipment. Check whether you really need fancy broadband, or to pay for conference calls when you could get them free on Skype.

Step 2: your first (shared) office
Your first office will usually be shared with other businesses or other people, unless of course you’re already a rich entrepreneur with a second home that can double as office space.

Choose an office where you pay a maximum of 5% of turnover for office space (or rent, excluding rates). You should expect total office costs to consume 10% of your turnover. If you get to 15%, we’d suspect that either you’ve overspent on furniture and printers, or your suppliers of office services are taking advantage of you as a newbie. In that situation you should drive a harder bargain with those suppliers.

Warning: you may not be ready for a step-up yet
So, what percentage of your turnover are you spending on office rent? How does that compare with other percentages? Such comparisons are worth taking note of: if the rent for your potential new office could be 5% of turnover but your profit is at 2%, you might want to consider postponing the move. Your operating costs, already high, will become a real danger if you step up.

Step 3 – your fully-fledged office
If you keep to the above rule that office space alone should cost you no more than 5% of your turnover, when you move to your very own office we would expect your total office costs to reach about 13% of turnover. And within the 13% we’d expect to see the following division (all percentages of total turnover):

  • 0.6 to 1% rates
  • 4 to 5% for receptionist / PA
  • 1% for IT & telecommunications
  • 0.5% for stationery and office supplies
  • 0.1% for courier services/bills
  • 0.5% for accounting and legal advice
  • 0.4% office transport

As for depreciation, it varies depending on how much you needed to invest in your new office at the beginning, but you should keep it within 1% of turnover.

If your total office costs rise above 13% or even reach 20% of your turnover, that is bad news. We’d want to take a look at your pipeline – and if it turns out not to be in the greatest shape, we’d advise the dreadful but necessary next step…

Intermediary Step: get yourself out of there!
Don’t hesitate to step down for a while. Don’t find excuses for staying put in an office that’s too expensive. You’ll find yourself having to push targets up just to cover that cost.

When to move up again?
Keep your eye on any changes in the percentage of your turnover taken up by office rent – at 3% of turnover you’re probably feeling the squeeze. But move out when you’re sure you simply don’t have enough space, physically, for the operation you want to run.

Final but: whatever you do, don’t move to a new office basing your cost calculations on future sales targets. Be sensible instead. Use the actuals from last year and a fairly cautious projection to establish what type of office you need and how much you can spend.