Overhead describes the money it costs to keep your doors open and the lights turned on for your business. You incur these costs whether you operate a manufacturing firm or a retail store. Your bookkeeper or accountant creates a separate account for each overhead cost. The costs are entered into your accounting system as they occur. At the end of the month, you create financial reports that show how much you paid in overhead costs. By comparing financial statements from previous months, you can see if your overhead costs are increasing or decreasing.

Costs to Run the Company

Overhead is the total amount of fixed and variable costs you incur from running your business. You can divide overhead costs into operating overhead costs and general overhead costs. Operating overhead is the indirect cost of manufacturing your product or selling your goods. It includes your indirect materials, indirect labor and supplies costs. General overhead is the administrative costs of running your business and the selling costs connected with selling your product or merchandise. This includes your office supplies, utility costs and marketing costs. These operating and general overhead expenses, though necessary, do not add value to your products or merchandise.

Fixed Overhead Costs

Fixed overhead costs are the expenses that do not change in the short term. They remain the same no matter how much you produce or sell. Some examples of fixed costs are your office and factory building rent, fixed salaries, the yearly insurance premiums and depreciation. Your fixed costs are either avoidable or unavoidable. You can get rid of an avoidable fixed cost by discontinuing a product or no longer purchasing specific merchandise for resale. Unfortunately, unavoidable costs like your business property taxes and fixed employee salaries can only be eliminated by going out of business.

Variable Overhead Costs

Variable overhead costs are normally lower than your fixed overhead costs. Variable overhead costs change in relation to number of goods you produce or items you sell. Your variable costs rise as you product more or purchase additional quantities of merchandise. They fall as you manufacture or purchase less. Some types of variable costs are the indirect materials and indirect labor used in manufacturing your product. For manufacturing and retail firms, the electricity, water and supplies consumed are also variable costs.

Accounting for Overhead

Your overhead and fixed costs are included on the income statement. For a manufacturing firm, the manufacturing overhead is added into the cost of goods manufactured. The total amount appears on the income statement. For a manufacturing firm and retail firm, the operating and administrative overhead costs are itemized and listed separately on the income statement. Your overhead and fixed costs reduce the profit you make from your sales.