Overhead is an accounting term that refers to ongoing business expenses. It covers everything from rent and payroll to stationery and advertising expenses. It's important for budgeting purposes and for determining how much to charge for products and services to make a profit. If your overhead is too high, it will reduce your profits and make your business less competitive.
Overhead refers to the ongoing expenses required to operate your business but does not include those that are directly related to manufacturing your product or delivering your service. For example, if your business makes widgets, the cost of metal is a raw material and is not considered overhead. The rent for your factory is overhead since you pay rent whether you're creating widgets or not. Accountants split overhead into two categories: fixed expenses and variable expenses.
Examples of Fixed Overhead
Fixed overhead expenses are costs you have every month, regardless of how many products you sell. It includes rent or mortgage, utilities, salaries and benefits, liability insurance, membership dues, subscriptions, accounting and depreciation on fixed assets and office equipment. Rent and payroll typically form the bulk of fixed overhead every month.
Examples of Variable Overhead
Telephone bills, office supplies, packaging, mailing, printing, marketing and advertising are variable expenses. These costs may increase or decrease monthly depending on how many products you sell, seasonal promotions and other variables. Many businesses estimate variable expenses based on an average of the annual total.
Semi-variable or mixed overhead is a combination of fixed and variable elements for your business. These recurring expenses may fluctuate and typically increase as your business grows. For example, a delivery company has fixed monthly vehicle loan payments and insurance premiums but gas and oil expenses generally increase during the winter due to holiday gift deliveries. Semi-variable overhead is not recorded separately from fixed and variable overhead on financial statements but may be helpful for internal use.
Tips for Reducing Overhead
In an economic downturn, or when business is slow, reducing overhead is one of the easiest ways to keep your bottom-line healthy. Consider subletting space in your current location or moving to a less expensive space. Transitioning to paperless communication reduces the cost of printing and stationery. Job cuts are a painful way to reduce overhead but some employees may see the advantage of working part-time, sacrificing some perks or job-sharing to keep the company afloat during tough times.