How to calculate overhead
As a small business owner, you should know how to calculate overhead costs. The most common way to calculate overhead costs is as a percentage of sales or labor costs.
Your goal as a business owner should be to keep your overhead proportion as low as possible. A small overhead proportion means that a high percentage of your expenses go directly toward the production of a good or service. Lower overhead ratios provide business owners with a competitive advantage.
A low overhead rate will allow you to better price your products, making you a more attractive option than your competition. Furthermore, a small overhead could also allow you to increase your profit margins, boosting your bottom line.
To calculate business overhead, you’ll need to first comb through every specific business activity, listing all of your expenses. You’ll want your list to be thorough. Look through your financial statements to ensure that you pinpoint each one of your costs. Once you’ve identified all of your business expenses, you’ll want to sort them into two categories: direct and indirect expenses. When doing so, ask yourself, “Does this expense result in the production of a good or service?”
Once you’ve sorted your expenses, add up all of the indirect costs for the month. Then look at the company’s income statement to determine your monthly sales. Once you’ve figured out your monthly sales, you can calculate your overhead ratio with the following equation:
(Monthly Overhead ÷ Monthly Sales) x 100 = Percentage of Overhead Cost to Sales
You can also measure your overhead costs compared to your labor costs. The Bureau of Labor Statistics indicates that the average U.S. wage increased by 3% between March 2018 and March 2019. With labor costs rising so rapidly, you’ll want to cut back on overhead expenses. The equation to do so is:
(Monthly Overhead ÷ Monthly Labor Cost) x 100 = Percentage of Overhead Cost to Labor
Knowing how to calculate overhead will put your business in a much better position to succeed. Owners who routinely consider overhead are more efficient when managing company finances.