Decoding Overhead Costs: A Global Guide

Overhead Costs (Definition and Examples)

In the complex world of business, understanding your overhead costs is pivotal to steering your enterprise to success. Overhead costs, often simply referred to as “overhead,” encapsulate the expenses that aren’t directly tied to producing a product or service but are essential to keeping the business running.

Contents

• What costs factor into my overhead?
• Fixed, variable, and semi-variable overhead
• How to categorize overhead expenses
• How to calculate overhead rate
• Overhead tax deductions

When you track and categorize your overhead, you can plan around expenses, get an accurate picture of your profit margin, and uncover new ways to conserve funds.

What costs factor into my overhead?

Overhead represents the resources you invest to maintain your business’s operational status. However, it doesn’t encompass expenses you incur to manufacture goods or deliver services, such as expenditures on raw materials and direct labor. These costs are referred to as COGS (cost of goods sold) and COS (cost of services).

For instance, when you purchase ingredients for croissants at your bakery, this cost is incorporated in COGS. But when you handle the insurance for your bakery’s delivery van, that belongs to COS. Both these outlays directly tie into your business operations and are associated with revenue generation.

On the other hand, expenses like the rent for your establishment, business insurance, hiring accounting services, and assorted administrative costs are overhead. These costs don’t directly influence your primary money-making operations but are crucial for the business’s continuous operation.

Overhead vs. operating expenses

Distinguishing between overhead and operating expenses is essential. While overhead encompasses the necessary costs for business continuity, operating expenses include both overhead and COGS/COS. Think of operating expenses as the comprehensive category that encompasses every expenditure in the process of running your business. Hence, overhead is a subset of operating expenses.

Overhead vs. G&A

G&A (general and administrative) expenses pertain to the entire organization and don’t necessarily correlate with core business activities—the actual product or service the business offers. These could range from business license fees, office supplies, HR personnel, to bank charges. These are indirect costs that the business needs to address, regardless of its project pipeline.

Conversely, overhead expenses have a more direct connection to the product or service the business offers but aren’t linked to specific projects. For instance, a project manager overseeing all company projects would have their salary considered as overhead. If there were no ongoing projects, the company might opt not to bear this expense.

Fixed, variable, and semi-variable overhead

Understanding overhead requires knowledge of its types: fixed, variable, or semi-variable costs.

Fixed overhead is consistent. For instance, if you rent a commercial space for your business, this rent remains unchanged monthly, regardless of business performance or external market dynamics.

Examples of fixed overhead include:

• Property tax
• Business insurance
• Interest on loan payments
• Regular janitorial services
• Web hosting
• Bookkeeping services
• Post office box rental
• Telecommunication plans

Variable overhead fluctuates based on usage or demand. Using the bakery example, if you utilize gas ovens, your gas consumption varies monthly depending on baking needs, leading to different monthly gas bills.

Examples of variable overhead are:

• Utilities like electricity and water
• Vehicle maintenance
• Infrastructure or equipment repairs
• Hiring temporary support staff
• Staff events or outings

Semi-variable overhead sits between fixed and variable overhead. For instance, you might have a regular phone plan with a fixed monthly fee, but incurring additional charges if you surpass data limits or make international calls.

Examples of semi-variable expenses might include:

• Employee bonuses, which might be awarded during peak seasons or year-end
• Some bookkeeping services that have a base fee but additional charges based on work volume
• Janitorial services that may charge extra for specific cleaning tasks

How to categorize overhead expenses

To maintain accurate financial records and generate precise financial statements, categorizing your overhead is imperative.

Overhead costs can either be general or fall into distinct categories. For instance, some overhead indirectly relates to your product creation, while others are the result of back-end operations.

Categories you might consider include:

• Selling overhead: Costs associated with marketing (online ads, signage, agency fees)
• Administrative overhead: Costs of running administrative tasks (accounting, payroll, HR)
• Research overhead: Expenses related to researching new markets or products
• Transportation overhead: Travel costs not directly tied to the product/service
• Manufacturing overhead: Costs related to maintaining production facilities

How to calculate overhead rate

Determining your overhead rate provides insight into how much you spend on overhead relative to revenue. This rate is beneficial to understand the actual profitability of each sale or service provided.

To calculate: $\text{Overhead Cost}÷\text{Sales}=\text{Overhead Rate}$

For example, if in a typical month you generate $13,000 in sales with an overhead of $1,600, the calculation becomes: $1,600÷13,000=0.123$ This results in an overhead rate of 12.3%.

Overhead tax deductions

Although overhead is a cost of doing business, there’s a silver lining: potential tax deductions. Depending on your local jurisdiction and business regulations, certain overhead costs may be tax-deductible. Familiarizing yourself with local tax codes and consulting with financial experts can help identify which expenses can be claimed, providing an avenue for businesses to minimize their tax liabilities.

In conclusion, overhead, while not directly contributing to product or service creation, is essential for business operations. Grasping the intricacies of overhead allows business owners to navigate their financial landscape more effectively and optimize profitability.

Embrace the Future with Fiskl Accounting

In the world of business, every cent counts, and understanding your overhead is the key to maximizing profitability. But managing these costs doesn’t have to be a daunting task. With Fiskl Accounting, small businesses around the globe are revolutionizing their financial management. Our platform not only helps you gain a comprehensive grasp of your overhead costs, but it also automates your accounting and provides real-time calculations of retained earnings for both accrual and cash modes, adhering to GAAP and IFRS standards. Dive into the future of accounting with Fiskl and ensure that your business remains not just afloat, but surges ahead with clarity and confidence.