What is an overhead?

In bookkeeping and accounting, overhead refers to the ongoing operational expenses or indirect costs that a business incurs to support its day-to-day operations and production processes but are not directly attributable to a specific product, service, or project. Overhead costs are essential for the smooth functioning of the business but do not contribute directly to the creation of a specific product or service. Instead, they contribute to the overall operational infrastructure and are allocated across multiple products or services.

Overhead costs can include a wide range of expenses, and they are typically grouped into categories such as:

1. Rent and Lease Payments: Costs associated with leasing office space, manufacturing facilities, warehouses, or equipment.
2. Utilities: Expenses for electricity, water, gas, and other essential services required to operate the business.
3. Salaries and Benefits: Salaries and benefits for employees who are not directly involved in the production of goods or services, such as administrative staff, management, and support personnel.
4. Insurance: Premiums for various insurance policies, including property insurance, liability insurance, and worker’s compensation insurance.
5. Depreciation: The allocation of the cost of long-term assets, such as machinery and equipment, over their useful lives.
6. Office Supplies: Expenses for general office supplies, stationery, and consumables used in daily operations.
7. Taxes and Licenses: Business-related taxes, licenses, and permits required for legal operation.
8. Maintenance and Repairs: Costs to maintain and repair equipment, machinery, vehicles, and facilities.
9. Communication: Expenses related to phone lines, internet services, and communication equipment.
10. Advertising and Marketing: Costs associated with marketing and advertising campaigns, brand promotion, and public relations efforts.
11. Professional Fees: Fees paid to external professionals, such as legal, accounting, consulting, and advisory services.
12. Travel and Entertainment: Expenses for business-related travel, client meetings, and entertainment of clients or employees.
13. Rent and Lease Payments: Costs associated with leasing office space, manufacturing facilities, warehouses, or equipment.
14. Training and Development: Expenses for employee training and development programs.

Overhead costs are an essential consideration in cost accounting and financial management. They are allocated to products or services using various methods, such as absorption costing or activity-based costing, to determine the total cost of production or service delivery. Accurate allocation of overhead costs ensures that pricing decisions and cost analysis reflect the true cost structure of the business.

Effective management of overhead costs is essential for improving profitability and operational efficiency. Businesses often aim to control and reduce overhead expenses without compromising the quality of products or services. Understanding the composition and allocation of overhead costs is crucial for making informed financial decisions and managing a business’s financial health.

Small business owners often rely on a bookkeeper for small business to handle day-to-day financial tasks.