Reduce Overhead Costs in 2023: A Step-by-Step Guide

what are overhead costs

What are Overhead Costs?

Overhead costs, also called "overhead expenses" or "operating expenses", are expenses associated with running a business that can’t be linked to creating or producing a product or service. They are the expenses the business incurs to stay in business, regardless of its success level.

Overhead costs represent all of the costs on the company’s income statement except for those that are directly related to manufacturing or selling a product, or providing a service.

A potter’s clay and potting wheel are not overhead costs because they are directly related to the products made. The rent for the facility where the potter creates is an overhead cost because the potter pays rent whether they're creating products or not.

Overhead cost examples

A company’s overhead costs depend on the nature of the business. A retailer’s expenses will be different from a repair shop or a crafter’s. Typical examples include:

  • Rent
  • Utilities
  • Insurance
  • Salaries that aren’t job- or product-specific
  • Office equipment such as computers or telephones
  • Office supplies

Types of overhead costs

Overhead costs can be broken down into three types:

  • Fixed
  • Variable
  • Semi-variable

Fixed expenses are the same every month – such as rent. Variable costs increase or decrease, depending on how busy the business is. This could include wages for certain employees. Semi-variable costs are those that are incurred regardless of the activity level, but which might increase as business gets busier.

For example, an accountant in the U.S. always use printer toner, but might use more of it in the first quarter of the year when preparing and printing tax forms for clients.

It is important to monitor overhead costs. Because they aren’t directly related to revenues, they can drain a business unnecessarily when not properly controlled.

The classic small business example of unnecessary overhead is the start-up entrepreneur who rents office space in a trendy location for an operation that could be home-based until growth requires more room for staff and equipment. The money spent on rent might be better invested in advertising or promotion for the new, unknown business.

What Are Overhead Costs? FAQ

What are overhead costs examples?

  • Rent
  • Salaries and wages
  • Utilities
  • Insurance
  • Office supplies
  • Equipment maintenance
  • Advertising and marketing
  • Professional services
  • Travel costs
  • Technology expenses

Which costs are overhead?

Overhead costs are those that are not directly related to the production of goods or services, but are necessary for the operation of a business. Examples of overhead costs include rent, utilities, insurance, legal fees, office supplies, advertising, payroll, and accounting fees.

What are 4 types of overhead?

  • Production Overhead: Costs associated with running a production process, such as machinery maintenance, rent, utilities, and depreciation.
  • Administrative Overhead: Costs associated with running a business such as employee salaries, rent, office supplies, insurance, and professional services.
  • Selling Overhead: Costs associated with marketing and selling products such as advertising, promotions, and commissions.
  • Financial Overhead: Costs associated with managing finances such as accounting, auditing, and taxes.

What are the 2 types of overhead costs?

  • Fixed Overhead Costs - These are costs that remain the same regardless of production or sales volume. Examples include rent, insurance, and administrative salaries.
  • Variable Overhead Costs - These are costs that vary with production or sales volume. Examples include utility bills, materials, and labor costs.