How lowering your overhead can help you avoid financial problems
by Gary Foreman
Why You Need a Spending Plan Instead of a Budget
Simplify Your Budget
When I was a boy, one local department store had a jingle that featured the repeated chorus of "low overhead, low overhead". They claimed to offer lower prices because they kept their 'overhead' down. If they spent less on rent and other fixed expenses, they could make a reasonable profit at a lower price.
I was too young to remember which store ran the ads. So I don't know how low their prices were or whether the ads filled the store with expectant shoppers. But I can tell you that the concept is correct.
And the same idea applies to our family finances. The lower your 'overhead' is the more likely that you'll avoid financial troubles. Let's see how this works.
First, what is 'overhead'? In the retail store, it would be the cost of rent, lights, insurance and payroll. Everything it takes to open the store to the public. Your family overhead is made up of all the money that you've committed to spending before the month begins.
We'll visit the Smith family for an illustration. How your family compares to their family isn't important. Just grasp the concept involved. In fact, you might want to jot down your own expenses to see what your 'overhead' figure is.
The Smiths have a 30-year, 4.5 percent mortgage for $150,000. That requires a payment of $760 per month to cover principal and interest. Like all homeowners, they'll need to pay property taxes and insurance. The combined expense adds another $2,400 each year. Or $200 per month.
Naturally, the Smiths will need electric, water, sewer and perhaps gas or oil for heating. Some months are worse for heating and air conditioning. But the average is $300 each month.
If we total that up, the Smiths have committed to spending $1,260 each month to keep a roof over their heads. Remember that's not including any maintenance, repairs or upgrades. We're just trying to identify how much they've committed to before the month begins.
Next, let's look at transportation. Like so many of us, the Smiths own two cars. Fortunately, they only have one car payment. Their minivan payment will cost them $453 for 48 months. Insurance and registration for both vehicles totals $1,600 a year or another $133 per month. So the cost of owning the two cars is $586 per month. Again, we haven't included the cost of gasoline or repairs.
The Smiths also have some credit card debt. They're carrying $8,000 at 14 percent interest. That costs them $93 each month in interest expense.
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Despite more than one attempt to quit, Mr. Smith still smokes cigarettes. Not a heavy smoker, but he still goes through $48 a month.
Mrs. Smith does her part, too. Each Friday for years she's been going out for lunch with some long-time friends. Usually they pick a moderately priced restaurant, but it still averages $9 per week by the time her portion of the tip is included. So that adds another $36 to our 'overhead'.
So how much are the Smiths committed to spending before the month even begins? Their total overhead is $2,023.
Next, let's see how that affects their finances. First, we'll look at how much income it takes to cover the overhead.
The Smiths are in the 25 percent tax bracket. Their average federal tax rate on all their income is 20 percent. They also pay 6.2 percent in Social Security taxes. Fortunately, where they live there's no state or local income tax. To cover the $2,023 in monthly overhead, they need to earn $2,741 each month. Or $32,894 each year.
Look at it another way. The Smiths combined income last year was $76,500. So of every dollar they make 43 cents goes to cover expenses that they have very little control over.
So what can we learn from the Smiths? Just like the retail store, we need to pay the 'overhead' first before we think about rewarding ourselves with new clothes or vacations. The more money needed for overhead, the harder it will be to feed our family, save for retirement, spend money on entertainment or anything else.
The question to ask before making any ongoing commitment is do I want to add this monthly expense to my overhead. Is it really more important than all the other things that I'd like to spend money on?
Not only was "low overhead" a memorable jingle, it's also a good way to look at your family finances.
editor's note: article updated September, 2013
Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. Gary is available for audio, video or print interviews. For more info see his media page.
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