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In Business, what is Overhead?

Mary McMahon
Updated May 16, 2024
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Overhead, also known as indirect expenses, is the cost of running a business. Without these expenditures, a company would not be able to function, but they do not contribute directly to the generation of profits. In a simple distinction between indirect and direct expenses, the desk an employee sits at is considered an indirect expense, while the materials for the product the employee makes at the desk are a direct expense. Without the desk, the employee cannot work, but the desk does not produce profits, while the materials the employee works with to create a product do.

Business owners have to consider overhead when they price products and services, and sometimes it can be a serious problem. If a retail store selling clothing pays a great deal for a premium location, for example, it must charge high prices for its stock, but customers may not be inclined to pay those prices, because they cannot see the reasons why the clothes should be so expensive. In this situation, the store may be forced to slash prices, which could mean that it barely meets its operating expenses.

Some examples of indirect expenses include rent, utilities, taxes, licensing fees, insurance for employees, travel, accounting services, and fines. Without these expenditures, the business likely could not exist, making them a very necessary part of the business. Direct expenses include things like employee salaries and wages, wholesale goods purchased for the purpose of resale, and raw materials purchased for the purpose of manufacturing. These expenses are designed to create profits for the business so that the owner makes money.

The percentage of overall operating expenses taken up by overhead can vary, depending on an array of factors. Most business owners aim to keep the expenses as low as possible, but they also recognize that a failure to invest in a business can cause long term problems. Refusal to move to a better location or to provide competitive benefits to employees can result in a decline over time, eventually causing a business to fail or require it to dramatically restructure to cope with changes.

In most nations, overhead expenses can be claimed on taxes, because the government recognizes that these expenditures are not voluntary, and that they would not be made if someone didn't own and operate a business. Typically, the amount is deducted from the gross receipts of the business, along with other expenses, to arrive at an adjusted income that is used to calculate the tax rate the business owner must pay.

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Mary McMahon
By Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a SmartCapitalMind researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

Discussion Comments

By anon946742 — On Apr 22, 2014

Here is a situation. A company imports goods from USA and pay VAT according to C-79 form issued by HMRC and other Import and Custom Charges like Deferment fees, Air Freight charge, etc. I want to know how to allocate the Import and Custom duty? Overhead Expense or Operating Expense?

By anon311295 — On Dec 31, 2012

My boss has decided that he will allocate all overhead and direct cost to his key employees. They will then have to cover these costs from profits generated to the company. If they cannot cover the key employees will not be paid. Is this unusual?

By ronburg44 — On Sep 24, 2010

I work for a home town business but it is a large organization for the area. By no means would I call it a corporate business and it has always felt nice working for people that I could personally know on a first name basis. I could even shake the hand of the owner everyday if I wanted.

Recently they claimed to have a slow down in business and needed to reduce their overhead costs. The first thing to go was the employee coffee machine and supplies.

Now I've worked there for 22 years and never in my days have I had to buy coffee before work in the morning. This cost savings of maybe $50 a week for 30 employees has now created a disgruntled workforce.

Not only do I spend my own money now paying for coffee but I have to get up earlier to make sure I have time to either make it or stop by a cafe where there are usually lines. Moral of the story is, cut costs if you need to but cut employee benefits only as a last resort. Otherwise you will have to deal with some caffeine hungry tired employees.

By sammyG — On Sep 24, 2010

@FootballKing, I think it is important to remember that the employee comfort overhead costs are what keeps those hard workers happy and productive. If you look at it from the worker's perspective then you would see that the happiness level they have has a direct effect on their work performance.

Who wants to wake up everyday and drag themselves out of bed to a shower in a miserable apartment only to go to work and have their boss get upset because just this once you forgot to run the copies double sided.

It seems like some of the most harsh and demeaning cost cutting practices by employers are the ones that cut little perks out from the workers routine. If a company or business owner is looking to save a bit and bump up that profit margin just a bit then they will start taking away little things at first. Soon it will be the big things like health benefits and retirement plans, all so they get their extra bonus.

By FootballKing — On Sep 24, 2010

In my business, overhead costs make or break my profit. Whenever I can cut costs on things like rent or office supplies, I do so with a vigorous effort.

Most of my employees do not understand how there is a direct relation to our expenses and my profit. But I imagine it would be unless you saw the full financial reports. My biggest worry is employee comfort costs. I recently had an employee ask about the availability of in-office childcare. Can you imagine what the overhead costs on that would be?

Mary McMahon

Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a...

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