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Overview of Overhead Costs
Definition of
Overhead Costs
What are Overhead Costs? Overhead Costs, often referred to simply as overhead or operating expenses, are ongoing business expenses that are not directly attributable to the creation of a specific product or the delivery of a service. Instead, they support the overall operation of the business. Examples include rent for office space or a factory, utilities (electricity, water), administrative salaries (e.g., HR, accounting staff), insurance, office supplies, and property taxes on facilities. While not directly part of the Cost of Goods Sold (COGS), they are essential for the business to function. Many fixed costs fall under the umbrella of overhead.
Activities Related to
Overhead Costs
Here is a list of Overhead Costs related activities:Â
Tracking and paying rent and utility bills, Managing administrative staff salaries and benefits, Purchasing office supplies, Paying property taxes and business insurance premiums, Allocating indirect manufacturing costs to products (in manufacturing accounting), Budgeting for ongoing operational expenses, Implementing cost control measures for non-production expenses, and Analyzing the impact of overhead on overall profitability.
Effective bookkeeping is essential for monitoring and controlling these critical business expenses.
The Importance of
Overhead Costs
For small business owners, managing Overhead Costs is crucial because these expenses are necessary to keep the business running but can significantly erode profits if not carefully controlled. Unlike variable costs that fluctuate with sales, many overhead costs (like rent) remain fixed regardless of revenue levels. Understanding and monitoring overhead helps in setting appropriate prices to cover all costs, preparing accurate budgets, and identifying areas for potential savings. In manufacturing, proper allocation of overhead to products is vital for determining true product costs and making informed decisions about production and pricing.
Key Aspects of
Overhead Costs
Indirect Nature
Overhead costs are not directly traceable to a specific product, service, or revenue-generating activity. They support the overall business infrastructure.
Ongoing Expenses
These are typically recurring expenses necessary for the day-to-day functioning of the business, regardless of production or sales volume (e.g., rent, utilities).
Often Fixed or Mixed
Many overhead costs are fixed costs (like rent), while others can be mixed costs (like utilities with a base fee and usage charge). Some can also be variable in an indirect sense (e.g., office supplies might increase with more staff activity).
Concepts Related to
Overhead Costs
Overhead Costs are closely related to Indirect Costs as they are not directly tied to specific products. Many overheads are also Fixed Costs or Period Costs, meaning they are expensed in the period incurred. They are a significant component of a company's Operating Expenses. In cost accounting for manufacturing, overhead (manufacturing overhead) is allocated to products to determine total product cost. Effective budget planning requires careful estimation and control of overhead costs.
Overhead Costs
in Action:
The Adventures of Coco and Cami
Follow Coco and Cami as they realize that beyond ingredients and labor, they also have to pay for things like rent, electricity for the shop, and their business insurance.
Watch as Professor A explains Overhead Costs to Coco and Cami, helping them understand these essential but indirect expenses of running their businesses.