Overhead, otherwise known as overhead costs, refers to the ongoing expenses associated with operating a business. Understanding your overhead costs and keeping them under control is essential to success as a business owner.
Overhead costs represent business expenses that are not directly related to making a product or performing a service. Expenses such as rent, utilities, and insurance, are generally fixed costs that cannot be attributed to a specific product or service. On the flip side, labor, machinery, materials, and other production costs are not considered overhead.
Overhead Costs + Cost of Goods Sold (COGS) = Operating Expenses
As stated above, overhead costs are expenses that are unrelated to what the business is selling, while the cost of goods sold (COGS) are the expenses associated to a business’s products or services. Overhead costs are just one factor of a businesses total operating expenses. As an example, a restaurants overhead would include the costs associated with maintaining bathrooms, common areas, sanitation, lighting, and other utilities. Costs like ingredients, plates, packaging, and kitchen equipment would be examples of expenses related to the costs of goods sold (COGS).
Costs that remain the same every month, regardless of whether there is an increase or decrease in production are fixed expenses. The following list of examples include some common fixed expenses that you may find in your business.
- Employee Payments (Wage and salary, not including overtime or bonus payments)
- Real estate and property tax
- Utilities such as phone and internet
- Janitorial Service
- Mortgage interest
- The cost of setting up machinery and equipment
Variable expenses are the opposite of fixed expenses and represent the costs that increase with production or activity. The following list of examples include some common variable expenses that you may find in your business.
- Utilities such as water or electricity
- Sales commissions
- Seasonal staffing
- Some debt expenses
Semi-variable expenses, or mixed costs, contain both fixed and variable costs and typically constitute a fluctuating increase in a fixed expense. Costs are fixed for a certain level of production or consumption but become variable once this production level is exceeded. The following list of examples include some common semi-variable expenses that you may find in your business.
- Raw material
- Direct labor costs (Overtime and Bonuses)
- Utility Costs such as cell phone bills or data packages
Categories include both general overhead expenses and specific categories of overhead expenses. General overhead expenses are those that affect the entire business where administrative overhead, selling overhead and other overhead categories are associated with specific business activities.
Administrative overhead are the costs related to the general management and administration of a company. The following list of examples include administrative overhead expenses that you may find in your business.
- Office supplies
- Human Resources
Selling overhead includes costs related to activities involved in sales & marketing. The following list of examples include selling overhead expenses that you may find in your business.
- Sales salaries, commissions, and related travel expenses
- Printed materials, advertisements, and tradeshow/showroom expenses
- Post sale services such as legal expenses for recovering debt
There are many other categories of overhead expenses and they are typically specific to the type of business. For example, manufacturing overhead represents factory related expenses that are not directly involved in the manufacturing of a product, such as factory supplies or the electricity need to power the facility. The best way to identify and categorize your overhead costs is to understand all aspects of your business and the activities associated with producing your goods or service and maintaining operations in general.
Overhead Rate Calculation
Overhead rate is the amount your business spends to provide your customers with your product or service. Understanding the rate of overhead is crucial as it prevents you from overstating profits so that you do not pay more income tax than necessary. While there are numerous ways to calculate the overhead rate, below is the basis for any calculation:
Overhead Rate = (Indirect Costs / Allocation Measure)
- Indirect costs include the costs that are not directly tied to the production of a product or service
- The allocation measure is what is necessary to produce the product, service, or time period (direct labor hours, machine hours, etc.)
- Overhead rate is calculated based on a specific period and/or business activity so it’s crucial to understand what you wish to analyze
Understanding how much it costs in overhead to produce a specific product or service, management can more effectively manage the business’s profit margin. In general, companies that are successful in monitoring and managing their overhead rate are well-positioned to improve their bottom line or profitability.
Reducing Overhead Costs
Reducing overhead costs is a great way to increase profitability, increase cash flow, and in turn, protect your business in the event of unexpected expenses or a reduction in sales.
Below are some areas that can help you reduce some common overhead costs.
- Cut travel expenses. Travel can be very costly so try to limit unnecessary trips and expenses as much as you can. Look into bundled travel plans, travel around cheaper flight times (Red-Eye, etc.)
- Marketing has become increasingly more targeted with technology, meaning you can spend your marketing dollars more efficiently. Carefully review all of your marketing strategies and replace unproductive channels and campaigns with free alternatives. We have seen extremely successful campaigns with next to nothing in expenses.
- Evaluate your business needs and negotiate with your vendors. Cutting unnecessary expenses and renegotiating with your vendors and suppliers can save you serious monthly costs.
- Hire a professional accountant to ensure your cash flow is well managed and that you receive all qualified tax deductions.
- Making good hiring (and firing) decisions. Replacement costs can be high but if a current employee is hurting your business or not being productive, you cannot be afraid to let them go.
If you need to reduce your companies overhead expenses, contact us at MCDA CCG and we can quickly identify areas and provide you with the solutions that are guaranteed to improve your bottom line. Call us at (714) 872-2393 or email firstname.lastname@example.org. You can also complete the form below and one of our experts will contact you shortly.