What is Overhead Cost?

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A business typically incurs two main categories of expenses: overhead and operating expenses. Operating expenses refer to those that a business incurs resulting from its normal operations. Overhead expenses, on the other hand, are what it costs to run the business.

What is the overhead cost?

Overhead cost refers to those costs that are not related directly to the production activity and are considered as indirect costs that need to be paid even if there is no production. Examples of overhead costs include rent payments, utility payments, insurance payments, salary payments to office staff, office supplies, and the like.

Overhead cost is the cost of indirect labor, indirect material, and other operating expenses that are normally associated with the typical day to day operation of the business but must not be charged directly to a specific product or service or cost center. In short, it is the cost the company incurred on material, labor or services that should not be economically identified with a specific saleable cost of goods or services per unit of the business. Overhead cost is indirect in nature and needs to be shared out among the cost units as precisely as possible.

Overhead cost refers to all expenses other than labor that are required to operate a business. These expenses can be classified as either fixed or variable.

Fixed Costs

Regardless of the sales volume the company generates, fixed costs are to be paid every month. Fixed expenses include payments for rent or mortgage, fixed assets depreciation such as office equipment and company cars, salaries and other payroll costs, liability and other insurances, utility costs, membership dues, subscriptions which may be affected by sales volume, and accounting and legal costs. These expenses do not change, regardless of whether the revenue of the company goes up or down.

Variable costs

Most of the business’ variable expenses are semi-variable costs that fluctuate from month to month based on sales and other factors, including change of season, promotional efforts, and variations in the prices of services and supplies. Falling under this category are expenses for office supplies, telephone, printing, mailing, packaging, promotion, and advertising. Typically, the more business the company is engaged in, the greater the use of these items.

When a company estimates its variable expense, it must use an average figure based on an estimate of the yearly total.

Semi-variable overhead costs

Semi-variable overhead costs exist regardless of how the business is going, but the cost fluctuates slightly. These overhead costs could have a base rate that must be paid by the company and a variable rate that is determined by actual usage. Semi-variable overhead costs include some utilities, hourly wages including overtime, vehicle usage, and salaries and commissions of the salespeople.

An overhead cost may be treated differently depending on the business. An overhead expense in one company could be a direct production cost for another company. A good example is a marketing agency that will typically classify rent as an overhead cost, while a production facility will typically classify such rent as a direct cost.

Some types of expenses could be classified as both direct and indirect costs for your business, based on the situation. Wages paid to a seamstress at a dress shop might be considered as a direct cost because her output increases the revenue of your business. On the other hand, wages paid to an in-house accountant will be classified as an overhead cost.

Understanding overhead costs

Knowing your overhead costs will help you set prices that result in profits. Overhead cost is typically factored into the total cost to run your business, letting you know how much money your business must bring in.

You can also use overhead costs in determining your net profit, or bottom line. Take your gross profit and deduct all expenses, including overhead, to determine your net profit. Your net profit will tell you if your business is making money or if your expenses to operate your business are more than the revenue, in which case you are losing money.

What is the cost in business

Cost in business expresses the amount of money spent on the production or creation of goods or services. It does not include a mark-up for profit.

From a seller’s point of view, the cost is the amount of money that is spent on producing a product or good. The seller will break even when he sold the goods at the same price they cost to produce. The seller does not lose money on the sale, but he does not make a profit either.

The cost of a product from the point of view of a buyer is the price. This is the amount charged for creating a product by the seller, including the cost of making the product and the mark-up cost added to produce a profit.

Cost in accounting

In accounting, cost refers to the monetary value of expenditures for supplies, services, raw materials, labor, equipment, products, and more. Cost is the amount that is recorded in bookkeeping records as an expense.

When developing a business plan for a new company, organizers will make cost estimates to asses if the revenues and benefits of the proposed business will more than cover the costs. This process is referred to as cost-benefit analysis.

Underestimating the costs will result in a cost overrun once the business starts its operations. This simply means that the costs are higher than the income, and the company will bleed money.

The Cost Plus model is used by many companies in determining a sales price for a product. Cost Plus is when the Price = Cost +/- x %. X indicates the percentage of built-in overhead or profit margin that must be added to the cost.

Costs are important to a business because these are the things that drain away whatever profits the business makes. They are the difference between making a good and poor profit margin. Costs are also the main reason why a business suffers from cash flow problems. Costs change as the output or activity of business changes.

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