In our example, indirect costs such as postal rates and insurance are necessary to run a business, but not making a product. As you calculate your overhead, make sure to consider whether something is a fixed cost or a variable cost as well. [5] X Expert Source Madison BoehmBusiness Advisor, Jaxson Maximus Expert Interview. 29 September 2021. Fixed costs are those that do not change, and variable costs are those that change according to your business’s activity and level of production. [6] X Research source
The most frequent direct costs, as illustrated above, are wages and materials. In simplified terms, direct costs pay for the things on the assembly line, while indirect costs pay for actual assembly line.
Be consistent with your time-frame – if you calculate indirect costs monthly, you must calculate direct costs monthly too. Using computer programs like QuickBooks, Excel, or Freshbooks can help you keep your list organized and accessible. [9] X Research source Don’t worry just yet about what expense goes where. You need the full picture of your expenses before you can calculate overhead.
Look over expense reports and receipts from the past to make sure you aren’t missing anything. Don’t forget about recurring expenses, such as renewing a license or filing permits, that occur infrequently. They still count as overhead.
If you have old accounting books, you can use those to plan for next year’s costs. Unless you are making large changes to your business plan, they are often similar numbers. Average your old costs over 3-4 months to adjust for any statistical anomalies.
If you are still confused, think of overhead costs as those you would pay if you stopped producing anything at all. What keeps your business running every day? Update this list every time you incur new expenses.
Divided indirect costs by direct costs. In the example above, our overhead rating is . 35 (16,800 / 48,000 = . 35) Multiply this number by 100 to get your overhead percentage. Here, 35% This means that your business spends 35% of its money on legal fees, administrative staff, rent, etc. for every product it produces. The lower your overhead rating, the larger your profit. A low overhead rating is good!
When this number is low, it means your business spends its overhead costs efficiently. If this number is too high, you might employ too many people.
Ex. If my business sells $100,000 worth of soap a month, and it costs me $10,000 to keep my office running, then I spend 10% of my revenue on overhead. The higher this percentage, the lower your profit margin.
All businesses pay overhead, but those that manage their overhead costs wisely turn a higher profit. That said, having low overhead isn’t everything. If you spend money on good equipment or worker satisfaction, for example, you might have higher productivity and higher profits.
