A business may take in one sum of money, but it is not likely that all of it can be considered profit. This is because a business is generally required to pay expenses. Those expenses are commonly referred to as overhead costs. Examples of this type of cost include salaries, maintenance, and production expenses.
It is common for businesses to track their net and gross income. This is important because these figures represent two different values. Gross income refers to all of the money that a business takes in. This figure may be very large.
Some businesses have a wide variety of expenses to pay, while others only have a few expenses. In either case, almost every business will have at least some overhead costs. Net income refers to the amount of money that remains once these costs have been deducted.
This amount can be significantly lower and may not exist at all. This is because it is possible for a company to have overhead costs that consume all of its income. In some instances, a company’s expenses can even cause them to be in debt.
Without calculating overhead costs, a business cannot know exactly how much money it is making. If ABC Toys buys its merchandise from a factory, some of the money that it receives from the merchandise must be used to not only buy more merchandise but also to pay for items such as electricity, transportation, and salaries. Even if ABC Toys manufacturers its own merchandise, there will still be costs such as purchasing machinery and raw materials.
How overhead costs are categorized depends on a company’s accounting methods. Some businesses are very basic in the figuring of their expenses. Other businesses, however, have very complex methods that may require various departments to individually access their overhead costs. Some businesses access them by category. For example, manufacturers may calculate their manufacturing expenses and their nonmanufacturing expenses separately.
Awareness of overhead costs is important for more than just knowing how much profit is being made. These figures often play an important role in a company’s competitiveness. A company generally needs to know what its expenses are when it is setting prices. Companies with a lot of overhead expenses are generally forced to have higher prices than those with fewer expenses. Therefore, knowing how much expenses are can allow for strategies to reduce these costs.