Overhead costs, often referred to as overhead or operating expenses, refer to those expenses associated with running a business that can’t be linked to creating or producing a product or service. They are the expenses the business incurs to stay in business, regardless of its success level.
Overhead costs are all of the costs on the company’s income statement except for those that are directly related to manufacturing or selling a product, or providing a service. A potter’s clay and potting wheel are not overhead costs because they are directly related to the products made. The rent for the facility where the potter creates is an overhead cost because the potter pays rent whether she’s creating products or not.
A company’s overhead costs depend on the nature of the business. A retailer’s expenses will be different from a repair shop or a crafter’s. Typical examples include:
Overhead costs can be broken down into three types:
Fixed expenses are the same every month – such as rent. Variable costs increase or decrease, depending on how busy the business is. This could include wages for certain employees. Semi-variable costs are those that are incurred regardless of the activity level, but which might increase as business gets busier. For example, an accountant in the U.S. always use printer toner, but might use more of it in the first quarter of the year when preparing and printing tax forms for clients.
It is important to monitor overhead costs. Because they aren’t directly related to revenues, they can drain a business unnecessarily when not properly controlled. The classic small business example of unnecessary overhead is the start-up entrepreneur who rents office space in a trendy location for an operation that could be home-based until growth requires more room for staff and equipment. The money spent on rent might be better invested in advertising or promotion for the new, unknown business.