Overhead refers to the ongoing business expenses not directly associated with making a product or delivering a service. These are the costs that remain even after all the direct costs of goods sold (COGS) have been paid. Examples of overhead costs include rent, utilities, salaries of non-production employees, insurance, and office supplies. It is essential for businesses to track their overhead expenses to ensure proper financial management and determine the pricing of their products or services adequately.
1. What is the difference between overhead and direct costs?
Direct costs are costs that can be tied directly to producing a specific product or service, such as raw materials and labor. Overhead or indirect costs, on the other hand, are the ongoing expenses that support the overall operation of the business, like rent and utilities, and can’t be immediately assigned to a product or service.
2. How does overhead affect a company’s profit?
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Overhead costs directly impact a company’s profit because they are subtracted from revenues to calculate the bottom line. If overhead costs are too high, it can lead to lower profit margins. Therefore, managing and reducing overhead expenses can increase a company’s profitability.
3. Are office salaries considered overhead?
Yes, office salaries or administrative salaries are considered overhead. This is because these costs are incurred regardless of the level of output the company is producing. It is part of the general operating expenses of the business.
4. How can companies reduce overhead costs?
Companies can reduce overhead costs in several ways including streamlining operations, automating tasks, finding cost-effective suppliers, and improving energy efficiency by reducing electricity usage. It is a continual process that requires regular review and adjustment.
5. How is overhead cost calculated?
Overhead cost can be calculated by adding all the indirect costs of operating the business over a certain period, like a month or a year. This total is then typically divided by the total direct costs or units produced over the same period to calculate the overhead rate per unit.