WHAT IS OVERHEAD COST AND HOW TO CALCULATE IT?

WHAT IS OVERHEAD COST AND HOW TO CALCULATE IT?

What is the overhead cost?

Overhead cost is the amount spent by a business to provide services and products to its customers. It includes all the expenses that keep your business flow.

Overhead is actually the ongoing costs to operate a business but do not add the direct costs linked with creating a product or service. It can be fixed, variable, or a combination of both. There are different categories of overhead. The income statement reports overhead expenses.

It may include:

  • Marketing costs
  • Selling costs
  • Labor costs
  • Annual costs
  • Administrative expenses
  • Monthly costs
  • Track costs
  • Production expenses

Keeping a record of overhead costs can help you grow in your business. It can also contribute to saving money and helping you manage your products and services in a better way.

Here’s what we cover in this article:

Types Of Overhead Costs:

There are basically three main types of overhead costs, these are:

  • Fixed Overhead Costs
  • Variable Overhead Costs
  • Semi-variable Costs

Fixed Overhead costs are the expenses that are consistent over time (e.g, rent). Variable Overhead costs are the expenses that fluctuate with time(e.g, shipping costs). Semi-variable costs are the expenses that are the combination of both fixed and variable costs(e.g, utilities).

Example of overhead cost:

Overhead costs are an essential element for a business as you can link them with the profit. Some examples are as follows:

  • Rent
  • Utilities
  • Insurance
  • Travel
  • Advertising expenses
  • Accounting and legal expenses
  • Salaries and wages
  • Depreciation
  • Government fees and licenses
  • Office supplies
  • Property taxes

Businesses must keep all the expenses in mind, including direct and indirect costs and must pay them on a regular basis, no matter how much the company sells. For example, a service-based business pays expenses including rent, utilities, and insurance that adds up to direct costs of providing its service.

How to calculate the overhead costs?

It would be much easier to calculate the business’s overhead cost if you categorize them over a while. Doing so will make it easier for you to calculate the overhead cost by the end of the month.

Remember that overhead cost is not a one-time calculation. You must separate direct expenses from the indirect ones to know how much overhead cost you have at the end.

After categorization, you need to add all overhead costs to get the total overhead price for an accounting period. You can easily calculate the overhead percentage, which tells you about the expenses of overhead expenses and charges of making a product or service separately.

 Calculation:

Divide the total overhead costs of the business of a month by monthly sales.

Then multiply this number by 100 to get the overhead rate.

Overhead Rate = Overhead Costs / Sales

By using this equation, you can easily calculate your overhead rate per month. 

How do you allocate overhead costs?

For allocating the overhead costs, you first need to calculate the overhead allocation rate.

Calculate the overhead allocation rate:

For calculation, we can use the following equation:

Overhead Allocation Rate = Total Overhead / Total Labor Hours

If the total overhead is $400 and total labor hours are 140 hours, then. 

Overhead allocation rate = $400/140  =   $2.85

It means you need to allocate $2.85 per hour to make a product.

Allocate overhead costs:

Allocate overhead by multiplying the allocation rate by the number of direct labor hours required to make a product.

 Let’s say, 

Product Y requires 50 hours; you must allocate $166.5 worth of overhead (50 hours x $3.33) to this product.

A business must calculate the overhead costs to balance expenses and profit regularly. Overhead costs have no direct link with the gain, but they impact yield as they are the extra costs of business that must be under control.

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