What is 'Overhead'
Overhead is an accounting term that refers to all ongoing business expenses not including or related to direct labor, direct materials or third-party expenses that are billed directly to customers. A company must pay overhead on an ongoing basis, regardless of whether the company is doing a high or low volume of business. It is important not just for budgeting purposes but for determining how much a company must charge for its products or services to make a profit. For example, a service-based business that operates in a traditional white-collar office setting has overhead expenses such as rent, utilities and insurance.
BREAKING DOWN 'Overhead'Overhead expenses can be fixed, meaning they are the same from month to month, or variable, meaning they increase or decrease depending on the business's activity level. For example, a business’s rent payment may be fixed while shipping and mailing may be variable.
Overhead expenses can also be semi-variable, meaning that the company incurs some portion of the expense no matter what, and some portion depends on the level of business activity. For example, many utility costs are actually semi-variable with a component existing as a base charge and the remainder of the charges being based on usage.
Overhead can also be general, referred to as company overhead, meaning that it applies to the company's operations as a whole. A company can allocate overhead to a specific project or department as well. For example, a service-based business that operates in a traditional white-collar office setting has general overhead expenses, such as rent, utilities and insurance, while it may have allocated overhead based on the activities completed within each department, such as printing or office supplies.
Categorizing Overhead Expenses
Overhead expenses may apply to a variety of operational categories. Administrative overhead most traditionally includes costs related to basic administration and general business operations, such as the need for accountants or receptionists. Selling overhead relates to activities involved in marketing. This can include printed materials, television commercials, as well as the salaries of sales staff and their corresponding administrative-support professionals.
Depending on the nature of the business, other categories may be appropriate, such as research overhead, maintenance overhead or transportation overhead.
Expenses related to overhead typically appear on a company's income statement as they directly play into the overall profitability of the business. The company must account for overhead expenses to determine net profit, also referred to as the bottom line. Removing the associated expenses from the gross revenues, also referred to as the top line, along with other production related expenses, accomplishes this.