What is Overhead Cost?

To measure a company’s operating costs, add all of the recurring business expenditures that keep the company running but don’t contribute to revenue generation. Administrative costs, selling and marketing costs, and manufacturing costs are examples of indirect costs. Regularly calculating and tracking overhead costs would help you save money, get a better price for your goods and services, and streamline your business operations.

How to calculate overhead Cost?

Follow the steps below to measure operating costs:

Step 1: Write down all your expenses:

Make a detailed list of all indirect company expenditures, such as leases, taxes, utilities, office supplies, plant repairs, and so on. Those are the costs of the overhead. Overhead costs do not include direct costs such as labour and raw materials used to manufacture goods and services.

Please note that certain products cannot be assigned to a particular group when categorising direct and overhead costs. Some business expenses can be considered overhead by others, but they are a direct expense for your company.

Step 2: Remember to include the overhead costs: 

To measure the net overhead cost, add all of the monthly overhead costs together. This is the sum of money you’ll need to run your business.

Step 3: Calculate the Overhead Rate:

The overhead rate, also known as the overhead ratio, is the cost of producing a product or delivering services to customers. Divide the indirect costs by the direct costs and multiply by 100 to get the overhead rate.

If your overhead rate is 20%, it means your company spends 20% of its sales on making a product or offering services. A lower overhead rate equates to greater productivity and earnings.

Step 4: Value For Capital: 

When it comes to pricing and budgeting, you’ll need to know what proportion of a dollar goes to overheads. Divide the monthly overhead cost by the monthly revenue and multiply by 100 to balance overhead costs to sales. For example, a company with monthly revenue of $100,000 and overhead costs of $40,000 has overheads of ($40,000/ ($100,000) x 100 = 40%.

Step 5: Compare to the cost of labour: 

Calculate overhead cost as a percentage of labour cost to assess how effectively company resources are being used. The lower the number, the better your organisation is at handling its resources.

How to Calculate Overhead Absorption Rate ?

Overhead absorption is the sum of indirect costs that are assigned to products and services. The indirect costs are difficult to track. For external financial reporting, both GAAP and IFRS need overhead absorption. 

Based on direct labour hours, machine hours, direct labour expense, and other factors, overhead is assigned to a product or service. The overhead absorption rate is used to account for overhead in the cost of products and services output. 

It’s used to specify the sum that will be deducted from the work in progress for indirect labour, material, and other indirect expenses. The absorption rate can be calculated in a variety of ways.

Direct Material Method Percentage: One of the most important components of product cost is direct material cost. The absorption rate is calculated using this method using the direct material cost. Divide the overheads by the projected or real direct material costs to arrive at this figure. Overhead / Direct Material Costs x 100 = Percentage on Direct Material Costs 

Method for Calculating Direct Labour Costs: 

The approximate or real cost of labour is measured as a percentage by dividing overhead by direct wages. Overhead / Direct Wages x 100 = Direct Labor Percentage

Method of Primary Cost Percentage: A business’s prime cost is its direct labour and direct material costs. Divide factory overhead by excellent cost to get the exceptional cost figure. Overheads / Prime Cost x 100 = Prime Cost Percentage

Method for Assessing Working hours: 

The factory overhead is divided by direct working hours to arrive at the labour hour average.

The formula is as follows:

Overheads/Labor Hours = Labor Hour Average

How to calculate overhead Cost per employee

Follow the steps below to measure the overhead rate per employee:

  • Calculate the labour expense, which covers the weekly or hourly wage and the employer-provided health insurance, holiday pay, pension, and retirement benefits.
  • Calculate the company’s gross overheads.
  • Subtract the operating costs from the billable hours. If your company has six technicians, for example, the overhead costs are shared among them.
  • The employee’s net cost per hour is determined by applying overhead costs and labour costs to billable hours.

A company can achieve a competitive advantage by lowering its overhead proportion, either by increasing profit margins or selling its goods more competitively.


In conclusion, These are the methods, features and functions of the overhead costs and how can you count them calculate them and use them to your benefit. I hope that this blog helped you and was worth your time.

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