All businesses have costs associated with operating the business. Tracking those costs is an essential part of managing a business’s finance, and involves categorizing expenses. Indirect costs of the business, those costs not associated with creating or producing a product or service, are commonly referred to as a business’s overhead costs. As these costs are not revenue generating, if not managed they can take up a large portion of a businesses budget. Identifying these costs and tracking them early on when starting a business is necessary for success.

 Types of Overhead Cost

Overhead costs typically come in three categories: fixed, semi-variable, and variable.

• Fixed costs: Fixed costs and constant costs that don’t change over time. These costs may include administrative salaries, rent, insurance, and anything else that has a set price. The important thing to remember about fixed overhead costs is that they will be the same every month.
• Semi-variable costs: Semi-variable costs are those costs that are always there, but may fluctuate in their actual dollar amount. Typically, semi-variable costs have a fixed amount and the variable comes into play when the cost exceeds the fixed dollar amount. For instance, utility costs may be higher for retail businesses during the holidays when they stay open for longer hours and/or have to run HVAC systems. Other costs, like advertising, may vary also depending on the marketing plan selected.
• Variable costs: Variable overhead costs are those costs where there is no fixed dollar amount, and the costs aren’t constant. For instance, companies that only engage in production during certain months of the year would consider those costs variable. Legal costs, when a lawyer isn’t on retainer, would be a variable cost. Small businesses that only use accounting services annually would consider that a variable cost.

Tracking Overhead Cost

While there are the three main types of overhead cost, they will typically be broken down differently for the company’s income statement. Larger companies may choose to categorize overhead cost by breaking it down into department, with a general category for overall business expenses. Other companies may choose to categorize their overhead costs based on the activity being performed. Where one company may choose to break overhead costs into departments, thus including administrative employees’ salaries in their respective departments; another company may choose to create categories based on specific categories, choosing to include all employee salaries in one specific category. There is no specific correct way to handle the break down of overhead costs, as long as all costs are considered and it works for the person in charge of accounting.

The Importance of Overhead Cost

Tracking overhead cost is essential for operating a successful business because it helps identify the bottom line. For instance, a retail company may take their overall sales for the month and consider it successful, but in order to determine their level of profit they need to consider total sales for the month, then subtract any direct costs (not included in overhead) as well as all indirect costs (also known as a business’s overhead costs). Once salaries, rent, utilities, etc. have been subtracted from total sales, only then does a business have a clear view of their net profit, or bottom line.