Overhead is the category of business costs that pays for the roof over your head and all the other infrastructure necessary to keep your business running. Your overhead cost does not change much as your business volume increases or declines, so any overhead cost calculation will show that the amount you spend per unit on these fixed costs declines as you sell more units.
The overhead cost per unit formula is straightforward and simple: just divide your overhead costs by the number of units sold.
Overhead costs are sometimes referred to as fixed costs, because they do not fluctuate relative to the expenses associated with producing your products and services. You pay the same amount in rent whether you sell two pieces of furniture or 200.
Some overhead expenses such as utilities can increase as your output builds, especially with a manufacturing business, which uses more power to produce more goods. However, the correlation between the production volume and the utility expense is far from clear and some utility expenses, such as keeping the lights on, do not change relative to production volume.
In contrast, the variable costs, or direct costs, that go into your cost of goods sold have a much cleaner correlation with your sales volume. It takes three times as much leather to make three pair of shoes than it does to make one pair. You may achieve some economies of scale through purchasing in volume or streamlining processes, but these costs still increase in a more or less consistent relation to the amount your company produces.
Calculate your total overhead expenses by adding up all of your infrastructure costs, or every expense that your business incurs that is not directly tied to the cost of production. If your company buys finished goods from another manufacturer, the cost of goods sold that is not included in overhead will be the amount you pay for the finished goods you will resell.
Divide the sum of your overhead costs by the number of units you sell. Include both large and small items because you are determining the cost per unit rather than the relationship between total revenue and overhead.
An overhead cost calculation is useful for determining the point at which your company breaks even and begins to earn a profit. The price you charge for your products must be enough to cover both fixed and variable expenses with some money left over, or profit. This profit will be your earnings from the business. To calculate the break-even point:
- Determine your average per-unit sales price. This may be an intuitive estimate of what the market will bear or a figure calculated using an industry standard, such as multiplying food costs by three for a food company.
- Calculate the variable costs for each unit by adding the amounts you expect to spend on materials and labor, and then dividing these sums by the number of units in a batch.
- Determine your overhead, or fixed monthly costs. Include rent, utilities, professional fees and any expenses your business would have to pay regardless of whether or not it takes in any revenue.
- Divide your monthly fixed costs by the average per-unit sales price minus your variable cost per unit. The resulting figure is your break-even point, or the number of units you must sell before you start earning a profit.
For example, if your overhead costs are $8,000 per month, your sales price is $10 per unit and your variable cost is $2 per unit, your break-even point is $8,000 divided by ($10-$2), or $8. You will need to sell 1,000 units before you begin to earn a profit.