Business Overhead Cost: Key Concepts and Calculations

In the relentless pursuit of business success, one formidable opponent continues to hinder progress: the business overhead cost.

It stealthily infiltrates profit margins, silently siphoning resources and leaving entrepreneurs scratching their heads in bewilderment. But fear not, for there are potent strategies to combat this financial nemesis.

So, what’s the secret sauce to reducing business overhead costs without sacrificing efficiency and quality?

First off, it’s all about embracing the power of technology. From cloud-based solutions to automated processes, leveraging tech can work wonders for slashing business overhead costs. Businesses report up to a 30% reduction in overhead expenses through cloud-based operations.

There’s more!

Streamlining operations and renegotiating contracts are also prime opportunities to rein in those pesky business overhead costs.

Are you ready to take the bull by the horns?

Buckle up and get ready to revolutionize how you manage your business expenses. This blog post has practical strategies and actionable tips that will help you conquer your business overhead cost woes.

It’s time to embrace change and lead your business to unparalleled financial prosperity.

Table of Content:

1. Define Overhead Cost
2. What Does Overhead Cost Mean?
3. What is Business Overhead Cost?
4. Why is Uses Overhead Cost in Business?
5. Types of Overhead Costs
6. 7 Examples of Overhead Costs in Businesses
7. Applications of Overhead Cost in Accounting  
8. Applications of Overhead Cost in Construction 
9. How to Calculate the Overhead Cost in Business?
10. Overhead Cost Formula
11. Overhead Cost Calculation Example
12. How to Analyze Business Overhead Cost?
13. Benefits of Calculating Business Overhead Costs
14. How to Reduce Business Overhead Cost?
15. Is salary an overhead cost?
16. Is depreciation an overhead cost?
17. FAQs About Overhead Cost
18. Wrap Up

First…

Define Overhead Cost

Definition: Overhead costs are the ongoing expenses associated with operating a business but not directly tied to production. They’re the not-so-obvious expenses that quietly nibble away at the money your company makes.

Things like rent, bills, insurance, salaries, and general business stuff fall into this category.

Think of overhead costs as the backstage crew of a big show. They are always there, doing their thing, but rarely getting the spotlight. Unlike costs directly linked to production, overhead costs cover the whole operation, ensuring everything runs smoothly.

To be money-smart, you need to grasp the basics of overhead costs. It’s essential for budgeting and figuring out where you can save money. It’s like learning the language of money for your business.

Here are some key components of business overhead costs:

• Rent or lease
• Utilities
• Salaries and benefits
• Insurance
• Office supplies and equipment
• Communication
• Maintenance and repairs
• Depreciation
• Taxes and licenses
• Marketing and advertising

What Does Overhead Cost Mean?

Overhead cost refers to ongoing business expenses that are not directly linked to production or revenue generation. These include rent, utilities, office supplies, insurance, and administrative salaries. Overhead costs are essential for business operations but do not directly contribute to making a product or service.

What is Business Overhead Cost?

Definition: Business overhead cost refers to the ongoing expenses required to run a business that is not directly tied to producing goods or services. These costs include rent, utilities, insurance, office supplies, and administrative salaries, ensuring the business operates smoothly.

Why is Uses Overhead Cost in Business?

Overhead cost is important in business because it helps determine the true cost of running operations beyond direct production expenses. Understanding overhead costs allows businesses to set accurate pricing, create budgets, and assess profitability.

By keeping track of these expenses, companies can identify areas for cost reduction, improve financial planning, and ensure they maintain healthy margins while covering all operational needs. Overhead costs also provide insights into long-term sustainability and growth potential.

Types of Overhead Costs

Overhead costs come in various shapes and sizes, each playing a unique role in your company’s finances. Understanding the nuanced roles of these costs, especially when analyzed alongside concepts like marginal revenue vs. marginal cost, enables you to navigate the complex choreography of financial management.

• Fixed Overhead Costs

Fixed costs remain steadfast, regardless of production levels. These encompass essentials like rent, salaries of permanent staff, and insurance. Think of them as the reliable anchors that provide stability in the financial sea. They ensure a baseline of expenditure irrespective of the business’s output.

• Variable Overhead Costs

These are the dynamic costs that change with the level of production. Expenses like utilities, raw materials, and part-time labor fall into this category. As production scales, so do these costs, offering flexibility in alignment with the company’s activity levels.

• Administrative Overhead Costs

The gears of daily operations turn with the support of administrative costs, often detailed in a small business expense report. These include salaries of management, office supplies, utilities, and other expenses essential for running the organizational machinery smoothly. Administrative business overhead costs are the backbone of the business’s day-to-day functionality.

• Production Overhead Costs

At the heart of manufacturing, production overhead includes costs beyond direct materials and labor. This encompasses expenses such as machine maintenance, factory rent, and indirect labor. These elements are essential for the production process but not directly tied to the end product.

• Selling and Marketing Overhead Costs

To bring products into the limelight, businesses incur selling and marketing business overhead costs. Advertising, salaries of the sales team, and promotional materials fall under this category. These are the expenses incurred in promoting and selling products.

• Research and Development (R&D) Overhead Costs

Innovation and staying ahead in the market come at a cost. R&D business overhead costs involve the resources dedicated to researching and developing new products or improving existing ones. This category includes salaries of research staff, prototyping expenses, and other costs related to staying on the cutting edge.

• Occupancy Overhead Costs

Beyond rent, occupancy costs encompass various expenses related to the physical space your business occupies. This includes property taxes, maintenance, and other expenses associated with maintaining a functional and welcoming business space.

• Indirect Labor Costs

Not all labor is directly tied to production. Indirect labor costs include the salaries of employees who support the production process indirectly. These include maintenance workers, janitors, and other staff members whose roles contribute to the overall operational efficiency.

• Finance and Accounting Overhead Costs

These costs are the financial guardians of a business. They encompass the expenses related to managing and safeguarding the company’s financial health. This includes accounting staff, software, auditing, and tools vital for the company’s financial well-being and health.

• Information Technology (IT) Overhead Costs

In the digital era, IT costs are an unavoidable reality. They cover expenses associated with maintaining and updating technology infrastructure, including software licenses, hardware maintenance, and IT support.

7 Examples of Overhead Costs in Businesses

1. Rent or Mortgage

This includes the cost of leasing or owning office space or other facilities. For businesses, these costs are fixed and must be covered whether or not sales are made.

2. Utilities

Expenses for essential services like electricity, water, internet, and heating are common overhead costs. These keep the business running smoothly but are not directly tied to production.

3. Insurance

Premiums for various types of insurance, such as property, liability, or employee health insurance, are necessary to protect the business from potential risks.

4. Salaries

Wages for administrative staff, management, or other non-direct employees who don’t contribute directly to production but are crucial for operations.

5. Office Supplies

Costs for items like paper, pens, printer ink, and other office materials. Though minor, these expenses accumulate over time.

6. Maintenance and Repairs

Expenses for keeping equipment, machinery, or business premises in working order. These costs help maintain operational efficiency.

7. Legal and Accounting Fees

Professional services for legal compliance, bookkeeping, tax preparation, and audits are important overhead costs for any business.

Applications of Overhead Cost in Accounting

1. Cost Allocation

Business overhead is allocated to products or services through methods like absorption costing or activity-based costing. This helps in determining the total cost of production for accurate pricing and profitability analysis.

2. Profitability Analysis

By tracking overhead expenses, businesses can evaluate their profitability. Identifying overhead costs ensures that companies understand their financial health and areas where cost-control strategies can be applied.

3. Budgeting and Forecasting

Overhead is a crucial part of budgeting and financial forecasting. It helps businesses project their future expenses and make informed decisions about resource allocation and operational efficiency.

4. Break-even Analysis

Including overhead in break-even analysis allows businesses to determine the sales volume needed to cover both fixed and variable costs. This analysis aids in assessing the sustainability of a business.

5. Tax Compliance

Properly accounting for overhead expenses ensures that businesses can maximize their tax deductions. Overhead costs are often deductible from taxable income, reducing tax liabilities while maintaining compliance with tax regulations.

Applications of Overhead Cost in Construction

1. Project Management & Administration

Covers salaries of project managers, engineers, and administrative staff to ensure smooth operations and coordination.

2. Equipment & Machinery Maintenance

Includes depreciation, repairs, and leasing costs to keep construction equipment functional and prevent delays.

3. Site Office Expenses

Covers utilities, office supplies, communication, and security at the construction site for efficient daily operations.

4. Permits & Legal Compliance

Includes costs for building permits, safety inspections, and regulatory compliance to avoid fines and ensure lawful operations.

5. Insurance & Safety Measures

Covers liability insurance, worker’s compensation, and site safety programs to protect employees and minimize financial risks.

How to Calculate the Overhead Cost in Business?

Calculating business overhead costs is akin to deciphering its financial DNA. It involves unraveling the indirect expenses that keep operations running smoothly. Here is a step-by-step guide on how to calculate business overhead costs.

1. Identify overhead expenses: Identify all indirect expenses incurred in running the business. These can include rent, utilities, insurance, and other operational costs not directly tied to a product or service.
2. Total direct costs: Separate direct costs from overhead by identifying expenses directly linked to production or service delivery. This includes raw materials, direct labor, and other costs directly attributable to creating a product or service delivery.
3. Allocate overhead: Allocate overhead to individual products or services based on a predetermined method. Common allocation methods include labor hours, machine hours, or a percentage of direct labor costs. This step distributes the overhead costs more accurately to the items being produced.
4. Review and adjust: Regularly review and adjust your overhead cost calculation methods to ensure accuracy and relevance. Business environments change, and so should your approach to calculating overhead costs. Stay vigilant to shifts in expenses and adapt your calculations accordingly.

Overhead Cost Formula

Calculate overhead rate: The overhead rate is the percentage of indirect costs relative to direct costs.
The formula for overhead cost is simple:

This rate provides a clear picture of how much overhead each dollar of direct cost carries.

Overhead Cost Calculation Example

Suppose XYZ Manufacturing Inc. incurs $100,000 in overhead costs and $300,000 in direct costs and produces 10,000 units of a product. The overhead rate would be calculated as follows:

Now, let’s say XYZ Manufacturing allocates overhead based on machine hours. Then runs the machines for a total of 5,000 hours during the production period. The overhead cost per machine hour would be $100,000 / 5,000 = $20.

If a specific product required 2 machine hours to produce, the allocated overhead cost for that product would be 2 hours x $20 per hour = $40.

How to Analyze Business Overhead Cost?

Data analysis is like solving a puzzle, except the pieces keep changing shape. And when it comes to analyzing business overhead costs, it’s like trying to find a needle in a haystack. But the haystack keeps growing.

This is where data visualization comes in. It helps to make sense of those mind-boggling spreadsheets and turn them into colorful, easy-to-digest charts and graphs.

Here’s the plot twist: Excel falls short when it comes to creating dynamic and interactive visualizations.

But fear not, for ChartExpo emerges as the hero of our story. It offers a solution to Excel’s limitations and empowers you to visualize data in ways never imagined before.

So, let’s conquer those overhead costs with the power of visualization.

But first!

Let’s learn how to Install ChartExpo in Excel.

1. Open your Excel application.
2. Open the worksheet and click the “Insert” menu.
3. You’ll see the “My Apps” option.
4. In the Office Add-ins window, click “Store” and search for ChartExpo on my Apps Store.
5. Click the “Add” button to install ChartExpo in your Excel.

ChartExpo charts are available both in Google Sheets and Microsoft Excel. Please use the following CTA’s to install the tool of your choice and create beautiful visualizations in a few clicks in your favorite tool.

Example

The table below contains business overhead cost sample data.

Overhead Cost Category	Cost as Percentage of Revenue (%)	Yearly Growth Rate (%)	Cost per Employee ($)
Rent	10	2	2500
Utilities	5	1.5	800
Administrative Salaries	15	3	45000
Depreciation	8	0.5	3200
Insurance	3	4	1000

Let’s visualize this data in Excel using ChartExpo and glean valuable decision-making insights.

• To get started with ChartExpo, install ChartExpo in Excel.
• Now Click on My Apps from the INSERT menu.

• Choose ChartExpo from My Apps, then click Insert.

• Once it loads, scroll through the charts list to locate and choose the “Multi-Axis Line Chart”.

• Click the “Create Chart From Selection” button after selecting the data from the sheet, as shown.

• ChartExpo will generate the visualization below for you.

• Click on Settings and change the “Data Representation” as follows.

• If you want to add anything to the chart, click the Edit Chart button:

• Click the pencil icon next to the Chart Header to change the title.
• It will open the properties dialog. Under the Text section, you can add a heading in Line 1 and enable Show.
• Give the appropriate title of your chart and click the Apply button.

• Change the precision value of the Yearly Growth Rate to zero and add the dollar sign:

• Change the precision value of Cost as a percentage of Revenue to zero and add the dollar sign:

• Add the dollar sign to Cost per Employee values:

• Change the Legend shape of Yearly Growth into Line and Circle and click the “Apply” button.

• Click the “Save Changes” button to persist the changes made to the chart.

• Your final Multi Axis Line Chart will look like the one below.

Insights

• Rent makes up 10% of the revenue, experiencing an annual growth of 2%, incurring a cost of $2500 per employee.
• Utilities contribute to 5% of the revenue, with a yearly increase of 1.5%, resulting in an expense of $800 per employee.
• Administrative salaries account for 15% of the revenue, growing at a rate of 3%, totaling $45000 per employee.
• Depreciation constitutes 8% of the revenue, with an annual growth rate of 0.5%, equating to a cost of $3200 per employee.
• Insurance represents 3% of the revenue, experiencing a yearly growth of 4%, with a cost of $1000 per employee.

How to Reduce Business Overhead Cost?

Business overhead cost reduction requires a strategic approach and a keen eye for opportunities. Here are practical strategies to help you trim the excess and bolster the financial health of your business.

1. Evaluate expenses: Scrutinize every item in your budget and spot areas where you can rationalize spending without compromising essential operations. For example, conducting a cost of living comparison by city can highlight discrepancies and opportunities for cost-saving. This diagnostic phase lays the foundation for targeted and effective cost reduction.
2. Streamline operations: Efficiency is the heartbeat of cost reduction. Streamlining operations involves optimizing processes to eliminate bottlenecks and redundancies. This enhances productivity and trims excess fat from the budget, fostering a lean and agile organizational structure.
3. Negotiate contracts: Flex your negotiation muscles when dealing with suppliers and service providers. Renegotiate contracts to secure favorable terms, bulk discounts, or extended payment terms. A savvy negotiation can yield significant savings, injecting a dose of financial flexibility into your budget.
4. Implement technology: Embrace the power of technology to automate and streamline tasks. Investing in efficient software and systems reduces the need for manual labor, minimizing both time and expenses. The right tech arsenal can be a game-changer in business overhead cost reduction, from project management tools to accounting software.
5. Outsource non-core functions: Consider outsourcing non-core functions to specialized service providers. This taps into expertise and eliminates the need for in-house resources for tasks outside your business’s core competency. Outsourcing is a strategic move that can drive down costs while maintaining operational excellence.
6. Energy efficiency: Cutting business overhead costs extends to your physical space. Implement energy-efficient practices and technologies to reduce utility bills. Simple measures like switching to LED lighting or optimizing heating and cooling systems can contribute to substantial long-term savings.
7. Remote work: The shift towards remote work is not just a response to global trends; it’s a strategic cost-saving maneuver. Remote work reduces the need for physical office space, associated utilities, and other overhead expenses. Embrace flexible work arrangements to unlock the potential for significant cost reductions.
8. Employee training: Investing in employee training might seem counterintuitive, but it’s a long-term cost-saving strategy. Well-trained employees are more efficient and less prone to errors, ultimately contributing to operational excellence. This proactive approach enhances productivity and mitigates the need for costly corrections down the road.

Is salary an overhead cost?

Yes, salary can be an overhead cost, but it depends on the employee’s role. Administrative and indirect labor salaries, such as those for office staff, managers, and HR personnel, are considered overhead costs because they do not directly contribute to production.

However, direct labor salaries, such as those for construction workers or factory employees involved in production, are not classified as overhead costs.

Is depreciation an overhead cost?

Yes, depreciation is an overhead cost when it applies to assets that support business operations but are not directly involved in production. For example, depreciation on office buildings, equipment, and vehicles used for administrative purposes is considered an overhead expense.

However, if the asset is directly used in manufacturing or construction, its depreciation may be classified as a direct cost instead.

FAQs About Business Overhead Cost

What is included in the overhead cost?

Overhead costs encompass indirect expenses vital for business operations. These include rent, utilities, administrative salaries, depreciation, and insurance. Unlike direct costs tied to specific products, business overhead costs contribute to the overall functioning of the business.

How do you justify overhead costs?

Overhead costs are justified as essential for business survival. They cover vital functions like administration, facilities, and support services. These indirect expenses ensure smooth operation and long-term sustainability of a company, contributing to efficiency and success.

What is a good percentage for overhead?

A good percentage of overhead varies by industry but generally falls between 15-45% of total costs. It depends on factors like business size and sector. Striking a balance ensures optimal resource allocation without compromising operational efficiency.

Wrap Up

Reducing business overhead costs is crucial for financial health.

Start by evaluating expenses meticulously. Identify areas where you can trim spending without compromising productivity.

Streamlining operations is key; optimize workflows to eliminate redundancies and enhance efficiency. Moreover, negotiating contracts with suppliers and service providers can yield cost savings.

Embracing technology is paramount. Automation not only streamlines tasks but also bolsters overall efficiency. Also, consider outsourcing non-core functions to specialized providers. This can reduce staffing costs and allow your team to focus on core business activities.

Prioritize energy efficiency measures to cut utility expenses and promote sustainability. The adoption of remote work options can lead to reduced office-related costs and increased flexibility. Moreover, prioritizing sustainability efforts will contribute to environmental responsibility and lead to lower operational costs.

Investing in employee training pays off in the long run. Well-trained staff can work more efficiently, potentially lowering errors and improving overall performance. Each cost-cutting measure contributes to a leaner and more agile business model.

Remember, it’s a continual process. Regularly reassess your overhead structure and adapt to changing circumstances. By implementing these strategies, you will weather economic challenges and position yourself for sustained growth and success.