What Is Overhead? 4 Types of Overhead You Need to Know
If you’re running a business, it’s important to know what is overhead and the different types of overhead costs. This blog post will explain everything you need to know about overhead.
I remember when I first started my business, I had no idea what is overhead or how to calculate it. It wasn’t until later on down the road that I realized just how important knowing this information can be.
What is Overhead?
These costs are important to budget for and keep in mind when pricing your products.
Overhead expenses are those that are in addition to the direct costs of providing a service. These overhead expenses must be covered in addition to the direct costs of labor and supplies to keep the business running.
Businesses need to include their operating expenses, such as payroll, on their financial statements. These costs directly influence their net profit.
Net profit is the amount of money a company makes after paying all production costs and operating expenses.
Fixed overhead costs stay the same regardless of how much the business makes, while a variable cost changes depending on a business’s level of production.
For instance, a company’s monthly rent payments may remain constant, while shipping costs and postage fees may vary.
Other examples include the depreciation on a fixed asset, the insurance premium, and the office employee salary.
Some overhead costs can be variable, meaning that a company can incur some portion of it regardless of the level of sales, and the other part depends on how much revenue the business generates.
A semi-variable rate, or tiered pricing, is a pricing structure where customers pay different rates depending on how much they use.
Examples of Overhead
Overhead costs are the expenses that a company must pay to operate. Some examples of these costs include rent, utilities, administrative costs, insurance, and employee perks.
Rent and Utilities
The overhead costs of maintaining a physical office or factory include expenses such as monthly rent, utility bills, internet service, and phone bills.
Virtual meeting platforms, such as (Zoom), are another cost that companies must consider when budgeting for outbound sales.
One of the more expensive aspects of running an office is the administrative cost. This includes the salary of office staff, the costs associated with keeping office supplies stocked, and any external legal or auditing expenses.
Running a business requires a lot of expenses, from buying supplies to paying employees. By keeping track of these expenses and minimizing them where possible, you can ensure your business is running as smoothly as possible.
Businesses need to hold many types of insurance policies to operate legally.
Insurance policies protect businesses from a variety of different threats. These may include property damage, professional liability, and employee health. Additionally, companies may purchase auto insurance for any cars owned by the business.
Although the costs of these insurance policies don’t directly generate profit, they are usually required by law.
Some companies provide employees with perks such as free coffee and food, gym memberships, and retreat trips. These are called “overhead” costs, as they don’t directly impact the business’s product or service.
Types of Overhead
Many types of overhead expenses may apply to different areas of your business.
The expenses incurred from general management and administrative tasks such as accounting, HR, and receptionist costs are classified as general and administrative overhead.
Overhead costs refer to the expenses associated with marketing, advertising, and selling a product. These can include printing, TV ads, and employee salaries. By knowing these, you can better determine the price of your product or service.
Other possible categories of overhead for businesses can include research, maintenance, manufacturing, or transportation. The type of overhead that is most appropriate for a business depends on the nature of that particular business.
How to Calculate Overhead
Overhead is often lumped together as a general cost, so it’s not always broken out. This means it’s usually allocated as a lump sum. This is then assigned to a product or service.
The overhead rate is computed by dividing the indirect costs by the allocation measure. The allocation measure can be direct labor costs, machine hours, or some other measure that is representative of the use of indirect costs.
There are four types of overhead: indirect material, indirect labor, other indirect costs, and depreciation.
Indirect material is the cost of materials that are not directly used in the production process.
Indirect labor is the cost of labor that is not directly involved in the production process.
Other indirect costs are those that cannot be directly traced to the production process.
Depreciation is the gradual loss in value of an asset over time.
What is overhead? As you can see, overhead is a very important concept for businesses of all sizes. If you’re not already tracking your overhead costs, now is the time to start. Doing so will give you a better understanding of where your money is going and how you can reduce expenses if necessary. And remember, if you ever have any questions about what is overhead or how to calculate it, be sure to ask an accountant or financial advisor for help.