How To Calculate Overhead Costs In 3 Easy Steps

Tools for calculating overhead costs

To paraphrase a familiar expression: Nothing is certain but death, taxes, and overhead costs. If you’re a manager or business owner, this maxim rings as true as its shorter counterpart.

That’s because overhead costs are something you always have to contend with whether you want to or not. They are part of the foundation of your business and often mean the difference between success and failure.

In this article, the management experts at Sling will answer all your questions about overhead costs and help you get a handle on this important business expense.

What Are Overhead Costs?

Manager's desk where they calculate overhead costs

Overhead costs are recurring expenses that sustain your business but don’t contribute to income. These expenses are often called indirect costs because they are not part of business activities that generate revenue.

This type of cost can be divided into three categories: fixed, variable, and semi-variable.

Fixed Overhead Costs

Fixed overhead costs are the same from month to month. Examples include:

  • Rent or mortgage payments
  • Some utilities
  • Property taxes
  • Insurance

Variable Overhead Costs

Graph showing overhead costs

Variable overhead costs are affected by business activity. When business activity goes up, variable overhead costs will too.

Examples of variable overhead costs include:

Semi-Variable Overhead Costs

Semi-variable overhead costs fluctuate slightly from month to month based on usage. Examples of semi-variable overhead costs include:

  • Some utilities
  • Wages (and overtime)
  • Vehicle use
  • Repairs and maintenance

These divisions become less important when you calculate overhead costs, but it’s vital to the operation of your business to know the difference between the three types.

Are Overhead Costs The Same For Every Business?

Overhead costs are not the same for every business.

For example, if you run a recording studio, you might categorize rent as a direct cost because it contributes to revenue. But if you run an ad agency, you might categorize rent as an overhead cost because the building in which you work doesn’t affect your income.

If you’re unsure how to classify an expense, talk to an accountant familiar with your industry.

Why Are Overhead Costs Important?

Coins in a jar

Depending on your business, overhead costs make up a large portion of the money you spend every month. Knowing and controlling them can mean the difference between profit and loss for your business.

Here are a few benefits of calculating your overhead costs:

  • Helps you set pricing for your goods or services to produce profits
  • Tells you how much money you need to break even
  • Gives you insight into your bottom line (a.k.a. net profit)
  • Reveals expenses that you can then work to reduce

Now that you understand what overhead costs are and why they’re important, let’s turn our attention to how to calculate and control them.

How Do You Calculate Overhead Costs?

1) Look At What You Spent Last Year

The easiest way to get started calculating your overhead costs is to look at a list of expenditures from the previous year. You don’t need every transaction, just the general categories.

Here’s a basic list of yearly expenses:

  • Electricity
  • Mortgage
  • Natural gas
  • Insurance
  • Supplies
  • Wages

If you use an accounting program, print out a report that lists these annual expenses. Or take a look at your income tax report to see what the IRS categorizes as expenses.

2) Determine Your Monthly Overhead Costs

Manager looking at overhead costs

The yearly numbers you see in step one are just totals. They’ll give you a general idea of what you’re spending, but it’s more useful to reduce those numbers to a monthly component.

Why look at a month and not just the year? Because even if you pay certain expenses on an annual basis, you should set aside money every month to cover the cost.

Insurance is a prime example. Your insurance bill arrives every twelve months, but you don’t want to leave it to chance that you’ll have enough money to cover this expense. Divide your premium by 12 and earmark that amount only for insurance at the end of the year.

Other expenses — like electricity and natural gas — are pretty much the same from month to month, so you can base your overhead costs calculations off the bill they send you.

Here’s a basic example of monthly expenses:

  • Electricity        $100
  • Mortgage         $500
  • Natural gas      $100
  • Insurance        $100
  • Supplies           $100
  • Wages              $900

Remember, overhead costs are what you spend just to keep your doors open. The money you spend to buy a cake for your head waitress’s birthday isn’t this type of expense.

3) Add Up The Individual Expenses

Now that you know what you spend every month on electricity, insurance, wages, etc., add up those numbers to calculate your monthly overhead costs.

  • Electricity        $100
  • Mortgage         $500
  • Natural gas     $100
  • Insurance        $100
  • Supplies           $100
  • Wages              $900

TOTAL                $1800

The sum of all your recurring monthly expenses makes up your overhead costs.

How Do You Calculate Overhead Rate?

Money leftover after business overhead costs

Now that you know your overhead costs, you can calculate your overhead rate. Overhead rate is a comparison of your overhead costs to your revenue. This number is usually expressed as a percentage of your income. Here’s the formula for overhead rate:

Overhead Rate = Overhead Costs / Income From Sales

Let’s say you brought in $28,000 last month and spent $1,800 in overhead costs. When you plug those numbers into the equation, it looks like this:

Overhead Rate = $1,800 / $30,000

Overhead Rate = 0.06 or 6%

For every dollar you made last month, you spent $0.06 on overhead costs. That’s pretty good. But, obviously, the lower your overhead costs the higher your profit.

Get Control Of Your Payroll To Reduce Overhead Costs

One of the largest overhead costs that all businesses contend with is payroll. The wages you pay your employees likely make up the bulk of your monthly expenditures.

Chart showing payroll as an overhead cost

You can get control of those numbers — and reduce overhead costs in the process — by harnessing the power of apps like Sling.

Sling’s labor costs feature gives you the ability to optimize your payroll as you schedule so that your spending doesn’t get out of control. You can set wages per employee or position and see how much each shift is going to cost.

Labor costs analysis

Sling also helps you keep track of your labor budget and will alert you when you’re likely to exceed the numbers you’ve set. Sling will even notify you when you’re about to schedule someone into overtime so that you can make the necessary changes.

Sling feature

And that’s only one of Sling’s many features that will streamline and simplify the way you organize and communicate with your employees.

For more free resources to help you manage your business better, organize and schedule your team, and track and calculate labor costs, visit GetSling.com today.

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