Overhead Costs: Formula and How to Calculate

Every business has costs and expenses that aren’t directly related to creating products and services. Known as ‘overhead costs’, these expenses must be tracked and factored into budgeting to keep the business running at a profit. 

In this guide, we’ll explain everything you need to know about overhead costs and provide an overhead cost formula to make calculation easy. Keep reading to discover why overhead costs matter, the different types of overhead costs, and how to navigate business expenses with confidence. 

Key Takeaways

• Overhead costs are indirect business expenses that keep operations running but aren’t tied directly to production.
• Tracking these costs helps you set accurate prices, improve budgeting, and protect your profit margins.
• Overhead costs can be classified as fixed, variable, or semi-variable.
• You can calculate total overhead using this formula: Total Overhead Cost = Indirect Labour + Indirect Materials + Other Overhead Expenses.
• Overhead costs vary depending on your business type and structure.
• Using accounting tools like Intuit QuickBooks makes tracking and managing overhead simpler and more accurate.

What is an overhead cost?

Overhead costs are the indirect expenses a business pays to keep its operations running, i.e. the costs that don’t directly produce goods or services but are still essential to keep everything in motion.

Unlike direct costs (such as raw materials or labour used to make a product), overhead costs cover everything that keeps your business functioning behind the scenes.

These costs can include:

• Rent and utilities: Keeping your office or workspace powered and running
• Administrative salaries: Wages for staff not directly involved in production
• Office supplies and equipment: Computers, stationery, or software subscriptions
• Insurance and professional services: Protecting your business and ensuring compliance
• Marketing and advertising: Promoting your brand and attracting customers

Why overhead costs matter in business

Understanding why overhead costs are meaningful will help you run your business more efficiently. When you have a clear picture of where your money is going, you’ll be able to make better decisions to keep your business financially resilient. 

Here’s why overhead costs matter:

• Supports accurate pricing: Knowing your overheads helps you set prices that truly reflect the cost of running your business (not just production).
• Improves financial planning: Regularly reviewing overheads makes it easier to forecast expenses, manage cash flow, and avoid budget surprises.
• Reveals inefficiencies: Tracking where funds are spent highlights areas where costs can be reduced or streamlined.
• Reflects business structure: Overhead costs are classified differently depending on how your business operates. For example, a service-based company may record more administrative overhead, while a manufacturer may have higher facility-related expenses.
• Builds stronger financial insight: Understanding overheads gives you a complete picture of your business performance, helping you make smarter strategic decisions.

Different types of overhead costs 

Overhead costs can look different depending on the type of business you run and how it’s structured. For example, a retail store might spend more on rent and utilities, while a service-based business may have higher administrative expenses. Manufacturers, on the other hand, often deal with overhead linked to factory operations and equipment maintenance.

In Malaysia, businesses generally group their overhead costs into three main types:

Fixed overhead costs

These are expenses that stay the same each month, no matter how much your business produces or sells. They’re predictable and easier to plan for in your budget.

Example: Monthly office rent or salaried employee wages remain consistent whether your sales go up or down.

Variable overhead costs

These costs change based on your level of business activity. When production or sales increase, these expenses tend to rise; when things slow down, they decrease.

Example: Utility bills or shipping costs may fluctuate depending on how much you produce or deliver.

Semi-variable overhead costs

Also known as mixed costs, these expenses have both fixed and variable elements. A portion stays constant, but part of it changes with activity levels.

Example: A business phone plan may have a fixed monthly fee plus additional charges if call or data usage exceeds a set limit.

Overhead costs formula

There are two main ways to calculate your business’s overhead costs, depending on whether you’re measuring your total overhead or working out an overhead rate. The first method is:

Total Overhead Cost = Indirect Labour + Indirect Materials + Other Overhead Expenses

This formula gives you the full picture of all your overhead costs combined. It adds up every indirect expense your business incurs, to help you see the total amount spent on keeping operations running smoothly.

This is the second method:

Overhead Rate = Indirect Costs ÷ Allocation Measure

This formula shows how much overhead is applied to a specific business activity (such as production, labour, or sales). It’s often expressed as a percentage and helps you understand how efficiently your resources are being used.

What are indirect costs?

In this context, indirect costs refer to the expenses that can’t be traced directly to the creation of a product or delivery of a service, but that still support daily business operations.

Examples include:

• Rent and utilities
• Office supplies and administrative wages
• Equipment maintenance or depreciation

What is an allocation measure?

The allocation measure is the basis used to spread overhead costs across different parts of your business. It helps determine how much overhead should be assigned to each product, project, or department.

Common allocation measures include:

• Direct labour hours or costs (for service-based or manufacturing businesses)
• Machine hours (for production-based businesses)
• Sales revenue (for retail or client-based businesses)

By applying these formulas, you can better understand how overhead affects your total expenses. You can also make more informed decisions about pricing and overall business performance.

How to calculate overhead costs

Next, we’ll explain how to calculate total overhead costs using the formula. 

To calculate your overhead costs accurately, you’ll need to allocate them to the right areas of your business. Start by identifying all overhead expenses (fixed, variable, and semi-variable) that relate to the same product, service, or department. This ensures you’re only including the costs that truly support that specific area. 

Once you’ve gathered these details, follow the steps below to calculate your overhead rate:

1. List all indirect expenses

Make a complete list of every overhead cost your business incurs. This includes rent, utilities, insurance, administrative wages, and other indirect costs that help keep your business running (but don’t directly produce a product or service).

2. Add up total overhead costs

Add all these indirect expenses together to find your total overhead cost. This gives you the total amount you spend on overhead for a specific time period (monthly, quarterly, or annually).

3. Determine the allocation base

Choose a measure that best reflects how your overhead costs relate to your business activity. This could be direct labour hours, machine hours, or sales revenue, depending on your industry. 

For example, a manufacturing business might allocate overhead based on machine hours, while a service business may use labour hours.

4. Calculate the overhead rate

Use the formula:

Overhead Rate = Indirect Costs ÷ Allocation Measure

This will show you how much overhead is applied per unit of your chosen base (for example, per labour hour or per RM1 of sales). The result helps you understand how efficiently your resources are being used and how overhead impacts your overall costs.

Example of calculating overhead costs 

Let’s look at a simple overhead cost example for a manufacturing business in Malaysia.

Imagine a small furniture manufacturer that wants to find out how much of its labour cost is spent on overhead. The business first adds up all indirect expenses for the month, including factory rent, utilities, equipment maintenance, and administrative salaries.

Example:

• Total Overhead Costs: RM40,000
• Direct Labour Costs: RM160,000

Now, apply the formula:

Overhead Rate = (40,000 ÷ 160,000) × 100 = 25%

This means 25% of your labour costs are spent on overhead. In other words, for every ringgit spent on direct labour, RM0.25 goes toward indirect business expenses like rent, utilities, or admin support.

Top tip: Accounting software such as Intuit QuickBooks can make your financial reporting and business financial management much easier. 

Navigating business expenses 

Understanding the different types of expenses your business records can help you track spending more accurately. Here’s a breakdown of common expense types and how they’re used:

How Intuit QuickBooks can support you

Intuit QuickBooks provides smart business tools that can track overhead costs and keep your finances organised. Designed to grow with your business, QuickBooks Online helps you generate reports so you can track performance with greater accuracy. 

Discover pricing plans to suit your budget and your needs. We offer free guided setup and unlimited support, plus you can cancel anytime. You can also find useful articles about growing your business in the QuickBooks blog.