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What are overhead costs?

Overhead costs are a company's indirect costs, such as utilities and payroll, not directly associated with producing a product. Find out more here.

Overhead costs are those company costs that are not linked to the production of a product or service. They are the expenditures made to keep the company’s day-to-day operations functioning. Overhead costs can be fixed, variable, or semi-variable. Calculating overhead costs is an important part of budget-making and pricing goods and services. 

The following are some types of overhead costs.

Fixed overhead costs

Fixed overhead costs are costs that are the same every month. 

Examples of fixed overhead costs include:

  • Rent payment

  • Vehicle lease payments

  • Mortgage payments

  • Insurance premiums

  • Taxes

  • Government licensing fees

  • Loan interest payments

  • Salaries - salaried employees are compensated with the same amount each month.

  • Fixed utilities -  some utilities may have a fixed monthly payment, such as sanitation 

Variable overhead costs

Variable overhead costs are costs that are different each month. These costs may fluctuate depending on business activity, productivity, and other factors that may affect the business temporarily. 

Examples of variable overhead costs include:

  • Labor costs such as overtime or temporary wages

  • Utility costs such as electricity, gas, and water

  • Internet connectivity costs

  • Accounting fees

  • Legal fees

  • Maintenance

  • Office supplies

  • Advertising fees

  • Administrative costs

  • Travel costs

  • Raw materials: depending on the production

Semi-variable overhead costs

Semi-variable overhead costs are overhead costs that are a mix of fixed and variable. 

  • Telephone bill. There may be a fixed monthly fee as well as a variable cost that depends on phone usage

  • Utility bill. Some utility bills include a fixed monthly cost regardless of whether the utility is used, in addition to the variable usage costs

  • Depreciation, which can have both a fixed and a variable portion

Overhead costs can be calculated for budgeting purposes and also to figure out how to price a product or service. Calculating costs accurately is an important step in reducing costs and making the company profitable. 

Calculating overhead costs requires identifying the various expenses, categorizing them, and gathering data. 

  1. Gather data. Make a list of all the indirect business expenses that do not have anything to do with the production of products or services. Also, list the direct costs of producing the product or services separately.

  2. Categorize the costs. Separate the overhead costs into three categories: fixed, variable, and semi-variable.

  3. Determine the total amount for each overhead cost. For each overhead cost, determine the total amount for a fixed period, such as a month. 

  4. Find the total overhead costs. Add up all the overhead costs for the period.

  5. Calculate the overhead rate. To calculate the overhead rate, divide the indirect costs by a measure of business activity, such as an hour of production or a certain number of labor hours. Divide the total overhead costs by the allocation measure.  

Companies can implement strategies to reduce overhead costs in general. The following are just a few ways your department and your company can help reduce overhead costs:k

  • Offer remote work. By making your department or your entire workforce remote, you can save the company money by cutting the costs of renting office space and any other costs of having employees come to the office. 

  • Go paperless. Have all HR paperwork go digital and send paperwork by email. This reduces paper, printing, and storage costs.

  • Lower the utility bill. Have smart lighting installed that turns off when there are no employees in a room. 

  • Outsource. Some HR functions may be outsourced to save costs.

  • Negotiate with vendors. Necessary HR-related functions such as background checks can be costly. Negotiate with the vendors to reduce this cost. 

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