Understanding Overhead in Business
Let me tell you directly: overhead is an ongoing business expense that isn't directly attributed to creating a product or service. As someone who's looked into this, I can say companies deal with numerous expenses, and overhead includes those everyday costs that aren't tied to a specific business activity, product, or service. These can add up significantly, they're often crucial or required, and they play a key role in how you budget and set prices.
You need to know that overhead can make or break your business. If you manage it well, you'll maximize revenues and profits.
Key Takeaways
- Overhead is an ongoing business expense not directly tied to product or service creation.
- Maximizing revenues and profits requires careful management of overheads.
- Overhead costs can be categorized as fixed, variable, or semi-variable, and administrative or production-related.
- The income statement reports overhead expenses.
- Examples of overhead include rent, utilities, and administrative expenses.
What Is Overhead?
Overhead consists of the business expenses that don't directly contribute to producing goods or providing services. These are typically recurring and stay constant no matter if your business is thriving or struggling. You'll see that overhead costs differ by industry, but common ones include insurance, rent, utilities, office supplies, taxes, depreciation on fixed assets, advertising expenses, permits and licenses, and accounting and legal fees.
Importance of Overhead in Business
Overhead costs, along with direct costs, determine your company's profitability. They're subtracted from revenue on the income statement to reach net income, which shows how much money you keep for reinvesting or distributing as dividends. Unlike direct costs, overhead doesn't directly drive revenues, but it's necessary to run the business and can indirectly affect sales through things like advertising or prime locations.
Since overhead usually remains constant regardless of revenue, it's used to calculate your breakeven point—the sales level where you start profiting. This makes overhead essential for pricing: you have to set prices low enough to attract customers and compete, but high enough to cover costs and make money. High overhead means charging more, which might lose you business; low overhead lets you stay competitive. But it's not straightforward—some overhead can't be cut without risking sales.
Types of Overhead
Overhead costs are typically fixed, variable, or semi-variable. Fixed costs remain constant no matter the business activity, like insurance, salaries, accounting services, and rent—they stay the same in good or bad months. Variable costs change with activity, such as sales commissions, shipping, and maintenance; they rise when business is up and fall when it's down. Semi-variable costs have both elements, starting with a baseline and increasing with usage, like utilities where you pay a fixed connection fee plus consumption-based charges.
Other Types of Overhead
You can also categorize overhead into administrative and production types, or add more based on your business. Administrative overhead covers general day-to-day costs like insurance, phone bills, office supplies, and wages for non-production staff such as managers, secretaries, janitors, lawyers, IT, and HR. You might break this down further into financial overhead (loans, taxes, accountant fees) or selling overhead (advertising, sales salaries). Production overhead includes indirect manufacturing costs like rent, property taxes, supervisor salaries, utilities, equipment depreciation, repairs, and maintenance.
Examples of Overhead
Overhead varies by company size and sector, but let's look at common ones. Rent is a classic fixed cost—you pay for offices or factories monthly, regardless of income, though you could reduce it by closing locations or moving, but that might affect staff or foot traffic. Utilities like water, gas, electricity, internet, and phone are essential, often semi-variable with a fixed minimum plus usage fees; you can cut them by switching suppliers or using alternatives.
Administrative costs are often the biggest, covering equipment like printers and desks, plus non-production staff salaries. You can trim these by layoffs, outsourcing, or cutting perks like free coffee, but overdoing it might hurt product quality or drive away customers.
Strategies for Managing Overhead
You have to manage overhead carefully since it eats into profitability—keep it low without damaging quality or sales. The key is smart spending: review costs regularly to spot increases and understand cut implications. Ways to reduce without harm include negotiating better rates with suppliers, outsourcing or insourcing services like IT or accounting, streamlining operations to eliminate waste, adopting remote work to save on offices and utilities, and using technology to automate tasks.
The Bottom Line
Overhead is the ongoing cost of running your business not directly related to producing goods or services, like rent, insurance, and administrative expenses. These costs reduce profitability but can indirectly boost sales if managed well, allowing competitive pricing, higher sales, and better revenue retention.
Other articles for you
Lucrative refers to any venture or activity that generates substantial profit after accounting for costs.
A 12b-1 fund is a mutual fund that charges investors fees for distribution and marketing costs.
Voluntary life insurance is an optional employer-provided benefit that offers a death payout to beneficiaries, funded by employee premiums.
Investment vehicles are various products investors use to achieve positive returns, ranging from low-risk options like bonds to high-risk ones like stocks.
The real economic growth rate measures a country's GDP changes adjusted for inflation to show true economic output growth.
Intestate refers to dying without a valid will, leaving asset distribution to a probate court.
Socially responsible investing focuses on funding companies and funds that promote positive social and environmental impacts while aiming for financial returns.
A QDRO is a court-issued legal document used in divorces to divide retirement plan assets between spouses or dependents.
Oligopsony is a market structure where a few large buyers dominate, exerting power to lower prices and influence sellers.
The temporal method is a currency translation technique used to convert a foreign subsidiary's financial statements into the parent company's currency using historical exchange rates for different items.