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What are Overhead Costs?

By Felicia Dye
Updated Feb 24, 2024
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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.

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Discussion Comments

By anon265166 — On May 01, 2012

Overhead costs can at times be so overwhelming, more than the direct costs themselves, and if not handled well, a company may find its way to industry exit. However, if you think you have done everything possible and you cannot reduce them any further, you may have to diverge your concentration.

Know your core competences as a firm and concentrate on them. They may increase your sales such that you do not have to worry about the overwhelming costs anymore.

By accordion — On Feb 25, 2011

It is easy for a business to become convinced that overhead costs cannot be changed, which can be a bad thing. A good practice is to have at least one member of a company whose duties include regularly looking for ways to cut costs, whether it be more energy-efficient lighting and heating, finding ways to cut back on office supplies, or any other ways to reduce spending without reducing productivity or employee morale on the job.

By wisemommy12 — On Jan 30, 2011

Overhead costs can break a company. Before starting a business it is extremely important to figure out what the fixed overhead costs will be. These are the costs that will be the same, no matter what, month after month. These will have to be paid whether or not there is any income. The wise thing to do is to make sure there is enough funding to cover these costs for several months, just in case it takes a while to start generating income.

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