What is Overhead?
Overhead includes all ongoing business expenses not including or related to direct labor or direct materials used in creating a product or service. A company must pay overhead on an ongoing basis, regardless of how much or how little the company is selling. It is important for budgeting purposes, but also for determining how much a company must charge for its products or services to make a profit. For example, a service-based business with an office has overhead expenses, such as rent, utilities, and insurance that are in addition to direct costs of providing its service. Overhead is any expense that supports the making or selling of a product or service.
Breaking Down Overhead
Overhead expenses can be fixed, meaning they are the same amount every time, 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 the company incurs some portion of the expense no matter what, and the other portion depends on the level of business activity. For example, many utility costs are semi-variable with a base charge and the remainder of the charges being based on usage.
Overhead can also be general, referred to as company overhead, meaning 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 may allocate overhead expenses 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 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 and television commercials, as well as the salaries of administrative-support professionals.
Depending on the nature of the business, other categories may be appropriate, such as research overhead, maintenance overhead, manufacturing 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 its net profit, also referred to as the bottom line. Removing the associated expenses from the gross revenues, referred to as the top line, along with other production-related expenses, accomplishes this purpose.