Overhead Costs

What are Overhead Costs?

Overhead costs are the indirect recurring costs of running a business such as administration, selling, and premises expenses.

They are all the support costs of a business which are not directly attributable to the goods or services that the business is producing.

Overhead costs continue to be incurred whether goods or services are produced and sold or not, this is in contrast to variable costs which only occur when goods or services are produced and sold.

Overhead costs are sometimes referred to as Fixed costs although they are not always actually fixed. Being fixed simply refers to the fact that the overhead costs do not vary directly in relation to the level of goods or services the business is producing. Overhead costs do not remain constant they tend to increase in steps as a business grows.

For example, a business producing widgets rents a manufacturing premises, the rent is an overhead cost and will not vary in relation to how many widgets are produced, the rent will still be payable whether widgets are produced or not. However, the rent is not fixed, over time it will change in stepped increases in accordance with the rental agreement the business has with the owner of the premises.

Why are the Level of Overhead Costs Important?

In order to break even a business must ensure that it has sufficient gross profit to cover its overheads.

In the example below, operating at its current level of sales, the business will start to lose money when the overhead costs go above 50,000.

Income statement
Revenue 100,000
Cost of sales 50,000
Gross profit 50,000
Overheads 30,000
Net income 20,000

For a given level of overheads, the level of revenue needed to break even can be determined by using the formula

Break Even Revenue = Overhead Costs / Gross Margin Percentage


In the example above the break even revenue at overhead costs of 30,000 is 30,000/50% = 60,000.

If the overhead increases by 5,000 the break even revenue rises to 35,000/50% = 70,000, an increase of 10,000, double the overhead increase.

It can be seen from this that as overhead costs rise the level of revenue needed to break even will rise. It is therefore important to keep the level of overheads as low as possible in relation to the size of the business.

Overhead Costs November 6th, 2016Team

You May Also Like

Related pages

the balance in the prepaid rent accountexample of perpetuitybookkeeping cash bookexplain double entry bookkeepingdebtors journalpayback formula exceldefine amortization in accountingprepaid insurance journal entry exampleaccounting formula cheat sheetmargin versus markup calculatorbond amortization schedule straight line methodbonds payable journal entrysubsidiary general ledgerhow do you calculate contribution margin ratioexcel npv functioncalculate unit variable costformula for profit margin ratioleverage ratio calculatorcalculator depreciationadjusting entry for notes payableaccounting ledger excelpresent value of infinite cash flowmarkup percentage calculationprepayments and accrualsmark up formulastraight line depreciation in excelfixed asset subsidiary ledgeraccruals and prepayments double entryhow to calculate markup on costtemplate for balance sheet and income statementfifo method in cost accountingexamples of accrued revenuewhat is meant by accounting equationtrade payables balance sheetexpanded accounting equation calculatormoh manufacturing overheadannuity present value calculatorclosing entry for dividendscash book entry exampleaccounting adjusting entriesfixed assets turnover ratio calculatorhow to calculate interest earned ratioasset turnover ratio formulacompute inventory turnovercogs definition accountingentries for bad debtsbank reconsjournal entry accounts payablepaid dividends journal entrypv function in excelwhat are adjusting entriesreceipt of money templatemortgage payable balance sheetwhat is the formula for retained earningsrecording adjusting entriesdeferred tax asset journal entryuses of standard costingaccrued expenses accountinghow is a common size balance sheet createdlifo calculation examplelump sum formulabad debt write offsincome tax provision accounting entriesprepaid freight termsbank cash book formataccounting methods cash vs accrualhow to calculate the variable costvalue of annuity calculator futureunder applied overheadwhat gaap stands forconsigned goodstie ratiounearned rent adjusting entry