Remember Pareto's Principle? Also called the 80/20 rule, it says that 20% of the input provides 80% of the value. Stated another way, 20% of your activities account for 80% of the results. Last month we applied the rule to job costs control. Now let's use the 80/20 rule to help develop an annual overhead budget.
The 80/20 rule tells us to focus on the important few and to ignore the insignificant many. In the sample overhead budget at right, 20% of the line items (6 of the 28 lines) account for about 75% of the entire amount. And the 3 labor-related lines — overhead, estimating, and the corresponding burden (highlighted in yellow) — make up more than half of the entire budget. These costs can be volatile if sales increase rapidly, so watch them closely. Over time, however, with the right people in these jobs, and with better systems and more training, you should be able to increase sales without much change to these costs. By focusing on the vital few, you control a big chunk of your overhead.
On the other hand, the next two largest budget items — depreciation and rent (highlighted in blue) — are likely to remain fixed no matter what happens to sales, so don't waste time with them this year. What about office supplies? Some savings may be possible by tracking where most of the costs in that line item are coming from. But notice that while a 10% change in office supplies pushes net profit up or down by $850, a 10% change in office overhead labor costs pushes more than $9,500 into or out of the bottom line.
The 80/20 rule works in both your business and in your life. In every crucial decision, focus on the 20% that's most vital; the remaining 80% will take care of itself. —Judith Miller is a Bay Area construction business consultant and trainer specializing in accounting, finance, and computerization.
