How to Calculate Overhead Cost For Your Business

Overhead costs are all the indirect expenses of running your business. Those are expenses that are necessary for your company to be functional, yet it is not directly linked to the creation of product or execution of service.

While it is not directly linked to production, they are an essential part of your enterprise. Determining the exact amount of overhead is crucial to be profitable.

What is Overhead Cost?

Overhead costs, often referred to as overhead or operating expenses, are all of the expenses you have to pay to keep your business running. It does not include COGS (cost of goods sold) or COS (cost of service).

Overhead costs tend to be fixed, meaning they do not oscillate from time to time.

Another way to determine an overhead expense is if the expense is tied to multiple jobs.

For instance, liability insurance is an overhead expense. It must be paid every month regardless of the job you are doing. Your company must have it to operate, but it is not linked to a specific operation.

Overhead Cost Examples

A company’s overhead costs will depend on the nature of the business. The expenses of a plumber working out of his van are drastically different than a retailer. Typically, it includes:

• Rent
• Utilities
• Insurance
• Salaries for jobs not related to production (secretary, office assistant, etc)
• Office equipment (computers, telephone, laptops, etc)
• Office supplies
• Travel
• Advertising
• Depreciation
• Fees and licenses
• Property taxes

Some organizations split these costs into manufacturing overhead and administrative overhead.

Again, costs linked to a specific job, should not be included with calculating overhead expenses.

You have to take overhead costs and direct expenses into consideration to accurately calculate pricing for service or product. Additionally, you should be thinking long-term so that you may earn profits in the long-term as well.

Fixed, Variable, and Semi-variable overhead

Every overhead expense will fall within one of these three categories: fixed, variable, or semi-variable.

Fixed Overhead

As the name implies, fixed overhead is expenses that are the same amount every month regardless of the business performance, or market forces. The same amount has to be paid every single month.

Fixed overhead includes:

• Property tax
• Business insurance
• Rent or mortgage
• Bookkeeping services
• PO box rental
• Phone plan

Variable overhead

Those expenses are costs that fluctuate. Examples of variable overhead include:

• Electricity
• Water
• Vehicle maintenance
• Staff events
• Building or equipment repair
• Seasonal staff

Semi-variable Overhead

Those are costs that fall in between variable and fixed. These are allocated to expenses that are unpredicted or vary depending on the occasion. Types of semi-variable includes:

• Staff bonuses
• Janitorial services
• Bookkeeping — they charge a monthly minimum and base their work on how much needs to be done

How Do You Project Overhead Cost?

To project the overhead cost of your business, you first need to categorize each expense for a specific time. While some prefer to select one-month expenses, I highly suggest doing it on a yearly basis and divide it by 12.

In the picture above, I identified all of the overhead expenses for the entire year. Notice that some of the expenses are in certain months, but not in others. That is why it is so important to calculate for the entire year.

The total expenses came to $54,540.

Let’s say that for the same scenario, the projected sales income is $272,130/yr.

To find the overhead rate, you would use the following formula:

Overhead cost / Sales = Overhead Rate

$54,540 / 272,130 = 0.20 or 20%

Be sure to add the overhead for each job. Keep in mind that if your sales do not meet the goals, your overhead rate increases.

By projecting your expenses for the entire year, you assist you in setting sales income goals.

For instance, you to maintain a 20% rate — which anything above 25% makes it difficult to have a good profitable business — you can reverse the formula and find the numbers to set the goals.

Remember that the $54,540 is total expenses for the year. Now you will have to find the monthly expenses

Yearly expenses / 12 (months) = monthly expenses

$54,540 / 12 = $ 4,545/month

The goal is to keep the overhead between 15% to 20%. Let’s say your goal is to have 18% overhead for the month of May. Using the following formula:

Monthly expenses / 0.18 = Sales goal

$4,545 (expense identified above) / 0.18 (the percentage you are aiming for) = $25,250 (the goal for your sales).

Overhead is the cost of staying in business — not including COGS and COS, which is calculated directly into the product or service you offer. It is essential for you to figure out the overhead expenses of your business as soon as you possibly can. These numbers are tools to ensure that your business is making money.