What is Overhead?
Overhead is made up of all of the expenses that are required to continually run a business. These expenses do not include the direct costs of producing goods and services. You’ll find overhead expenses listed on a business’s income statement.
Understanding overhead expenses helps a business to determine how much it should charge for its goods and services in order to make a profit. Overhead can be fixed, variable or semi-variable.
Fixed overhead refers to expenses that remain the same no matter the level of productivity. For example, rent is a fixed overhead expense.
Variable overhead expenses change with the level of a business’s output. The higher the output, the higher the costs incurred and vice-versa. For example, the cost of shipping a product goes up with every additional order you have to fulfil.
Semi-variable overhead combines fixed and variable expenses. For example, your water bill has a base price for the water itself (fixed expense) and the water bill will also vary depending on how much water you use (variable price).
Ask A Business Expert Explains Gross Margin
Administrative vs. Manufacturing Overhead – Example
Lets’ say that you have a bakery business. You know that you have to keep a close eye on all overhead expenses in order to keep your profits as high as possible.
With this in mind it’s worth knowing that overhead can often be grouped into two categories:
Manufacturing overhead and Administrative overhead.
Manufacturing overhead is the expense incurred during the manufacturing process. It is also known as production overhead. While Administrative overhead is the expense incurred outside of the production process.
So, in your bakery business, Administrative overhead will include expenses like:
- Employee salaries
- Bakery furniture for the comfort of your customers and employees
- Insurance and more
Manufacturing overhead expenses will include:
- Baking instruments
- Property tax
- Electricity, Gas, Water utility bills
Controlling overhead expenses is a critical part of making a business successful.
If you’d like to go even deeper and answer the question ‘Why Should A Business Owner Understand Their Gross Margin?’ then click on this link.
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