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How to Calculate Your Business Overhead: A How-To Guide to Help Business Owners Prepare For 2023 

Dec 13 2022

Overhead costs are the ongoing expenses that do not generate a profit, but a business must still incur to manage it and keep it running—and unfortunately, they’re unavoidable.  

Understanding your business’ overhead costs is essential to your daily operations and having a clear picture of your company’s expenditures creates opportunities to make a profit. Luckily, these costs come in different forms such as fixed, variable or both and there are ways to structure them strategically to ensure your business isn’t overspending unnecessarily. Having an accurate figure for your overhead costs is also a key element in calculating your net profit: gross profit less all expenses, including overhead, gives you your net profit. 

Overhead costs appear on a company’s income statement and accumulate even when business is slow, therefore it’s important to know exactly what these expenses are when they come up, so you can plan ahead for when less work is on the horizon. In preparation for the new year, here are some tips to help set your business up for success by further understanding and calculating all your overhead costs.  

  1. Be aware of all your expenses 

First, it’s important to have a good understanding of what your overhead expenses include. Companies must pay overhead and other expenses on an ongoing basis across a broad range of categories, no matter how big or small the amount!  

To effectively keep track of and calculate all the expenditures of your business, start by making a comprehensive list. This will help you stay on top of things and understand where your money is going. Costs such as your office rental, upkeep, insurance and taxes are just as important as other expenses such as stock, labor costs and material expenditures, so why not keep them all in one place? Now, how do you find your overhead?  

  1. Categorize this list 

Next, go one step further and categorize your list—calculations are a lot easier when you have everything as organized as possible.  

Remember, there is a difference between direct and indirect (overhead) costs when categorizing your expenses. Direct expenses are directly attributable to the production of the goods and services your company provides. This would include the cost of labour and materials required, for example. Categorization between overhead and direct costs will therefore depend upon the type of business you have, what you do and won’t be the same for every company. Additionally, it’s important to consider that some expenses don’t fall cleanly into one category or another and you may have to use your best judgement. There are protocols in each industry for how to list expenses as either direct or overhead costs. 

  1. Sum up your listed overhead costs 

Now is the time where you’ll be glad you categorized your expenses. Take your monthly overhead costs and add them together to calculate your annual overhead cost. The number you end up with can essentially be interpreted as the cost running your business.   

  1. Finding your overhead rate 

You’re left with a clear understanding of your total annual overhead costs and can now take it a step further to turn it into an insightful figure you can use to interpret your business spending. Your overhead rate, often represented as a percentage, is the cost allocated to the production of a product or service. To find the annual rate, divide your indirect (overhead) costs by your direct costs and multiply that by 100. When interpreting the rate, remember that the lower your overhead rate, the more profitable and efficient your company may be. You can always adjust the time period and calculate the weekly or monthly overhead rates as needed.  

  1. Compare 

Now that your calculated rate has given you an informed indication as to what your company is spending as overhead for products and services, you can compare it to other figures such as labour and sales, for example. These comparisons will help your business set accurate budgets and determine the efficiency of resource use. To calculate these, divide the overhead cost by either the labour cost or the sales, and multiply by 100 to represent it as a percentage. Again, the lower the percentage, the better.  

No matter your level of experience in calculating, categorizing and interpreting your company’s costs, this guide is not an exhaustive list and simply aims to give businesses a good starting point and crash course for understanding overhead and increasing your profits. It’s a complicated process! If you have any questions or require assistance or advice, our team at Mowbrey Gil is always ready to help fill in the gaps.   

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