Most owners watch sales at the top of the profit and loss account and profit at the bottom. What happens in between explains the gap, and one figure summarises it well: overheads as a percentage of sales.
The calculation
Overheads ÷ sales × 100 = overheads as a percentage of sales
Take a business with annual sales of £300,000 and overheads of £108,000.
£108,000 ÷ £300,000 = 36%
So 36p of every £1 of sales is being used to run the business — before any profit.
How it connects to profit
Now assume the gross margin is 45%. In simple terms:
45% gross margin − 36% overheads = 9% operating margin
That leaves £27,000 on £300,000 of sales
The relationship is worth watching because there are two levers, not one. You can improve profitability by protecting your gross margin, or by reducing overheads as a share of sales. Most businesses focus on one and ignore the other.
The percentage tells you more than the total
£108,000 of overheads, on its own, tells you nothing about whether the business is becoming more or less efficient. But if overheads were 32% of sales last year and are 36% now, that movement is worth understanding.
An important caution
Here is the part that is easy to get wrong, and it is worth being careful with.
Overheads are mostly fixed costs. So the percentage moves whenever sales move, even if spending has not changed at all.
- Grow sales with overheads flat, and the percentage falls on its own. That can look like good cost control when it is really just more sales landing on the same fixed base.
- Let sales fall with overheads flat, and the percentage rises on its own. That can look like overheads creeping up when nothing has moved.
So when the percentage changes, always ask the second question: did sales move, did overheads move, or both? The ratio alone will mislead you if you do not.
Overheads creep rather than jump
Very few businesses decide to increase their overheads. It happens gradually.
A subscription here. A service there. An extra £1,000 a month.
That is £12,000 a year — four percentage points of operating margin in the example above, and nearly half the profit. No single decision caused it, and no single decision will undo it.
This is why an annual review is not enough. By the time the year-end accounts show it, you have already paid it.
One classification point
What counts as cost of sales and what counts as an overhead varies between businesses. Some treat delivery or certain staff costs as direct; others do not. Neither is wrong, but it means industry comparisons are unreliable.
The most useful comparison is your own percentage over time, calculated consistently. If costs move between categories from one year to the next, the figures are not comparable and you will draw the wrong conclusion.
What to do
Check it monthly: overheads ÷ sales. Then ask whether the percentage is rising or falling, and whether sales moved, overheads moved, or both.
Alongside that, it is worth reviewing the overheads themselves once or twice a year — particularly recurring subscriptions and services, which are the easiest to accumulate and the easiest to forget.
Because if overheads are growing faster than sales, your profit can quietly disappear even while turnover looks healthy.
Regular management accounts put this figure in front of you as a matter of routine.
If you would like help reviewing your overheads and what they are doing to your margin, book a consultation.
