Business overheads: how to define, calculate and understand them

Keeping track of essential, ongoing business expenses like staff salaries and rent is very important to the long-term success of a company. These costs are known as business overheads.

Every business has overheads, and regularly reviewing these costs can ensure that money is being spent in the best way – and any cost savings can be reallocated to other parts of the business for a much needed boost.

This article will explore what business overheads are and how to calculate them, and share top tips for reducing them.

What are business overheads?

Business overheads are business expenses that aren’t directly related to the service or product you deliver to customers. Instead, overheads represent costs that relate to the general running of your business, like rent, staff salaries, utility bills, and insurance.

You’ll often hear about business owners trying to cut their overhead costs – this is because it is a cost you can have some control over, and cutting it won’t directly impact your customers.

For example, a business could cut their overheads by shopping around for a cheaper insurance provider, or choosing to use a more affordable accountancy service.

What are the different types of overheads?

There are three main overhead types to be mindful of:

• Fixed costs: Like it says on the tin, these are the costs that are fixed in your operation, like salaries, rent, and business insurance. These are costs that don’t change until your sign-up or contract period has ended or, in the instance of pay, until a pay review is triggered.
• Variable costs: These are costs that aren’t consistent but are important to be mindful of when budgeting – examples include freelancers’ fees and travel expenses.
• Semi-variable costs: This type of overhead is a fixed overhead that comes with a variable one – for example, a smartphone that has a monthly fee for usage.

It’s important to understand which category each of your overheads falls into so you can understand which costs could change, and prepare an appropriate backup fund should anything increase.

How can I calculate my business overheads?

Now you understand what a business overhead is, it’s time to look at how to calculate them. Start by categorising each of your business overhead expenses for a specific time period – we’d recommend doing this for each month.

Many businesses look at their overhead costs ‘per unit’, with ‘unit’ referring to the product or service they sell. The formula to use to work this out is:

(Total overhead cost) divided by (number of units produced) = overhead cost per unit

Let’s look at an example. If your business makes clothes, the direct costs of manufacturing, materials and labour – which don’t count as overheads as they relate directly to your product – may total £40 for a garment you sell at £100. This doesn’t indicate a 60% profit margin though, as overheads still need to be taken out of that percentage. This can be calculated using the formula above.

Using the clothing example, if the business had overheads of £70,000 and produced 7,000 garments in one month, the total overhead cost of £70,000 would be divided by the number of units (7,000), meaning the overhead cost per unit was £10.

This then means that the actual cost of producing a garment is £50, meaning the profit margin is 50% on the £100 clothing item.

This calculation should be used for each item or service your business delivers to ensure you fully understand the profit margins so that if raw materials, for example, increase in cost, you can decide whether a new higher price for the customer is a necessary move.

What is the best way to track my overhead costs?

Your business is flourishing, you have staff on the payroll to keep track of, and you’re thinking up new ideas to attract more customers – we know small business owners have a lot going on. It can be easy to lose track of expenses at the busiest of times, but making a conscious effort to keep track will help your business continue to grow in the long run and avoid any nasty financial shocks.

Here are three simple steps to make sure you’re on top of your business’s overhead spending:

1. Make a list of how much your business spends on overhead expenses every month, and keep it up to date
2. Separate your overheads into fixed, variable, and semi-variable costs
3. Every six months, review your overhead costs to see if you can reduce any of them. This could all be something an accountant or accounting software can help with.

It might seem obvious to track such expenditure, but these ‘given’ costs are often overlooked by business owners as need-to-haves that are static, when money can actually be saved with regular reviews.

How can I reduce my overhead costs?

Let’s take a look at how to reduce business overhead costs. Fixed costs offer less opportunity for review – for example, you may have committed to a shop rental for a three-year term, meaning that its cost will be fixed for that period.

However, when that tenure ends and if you feel the cost is too high, or the property isn’t what you’d hoped for, you have the opportunity to either attempt to renegotiate with the landlord or look elsewhere.

For variable and semi-variable costs, it’s important to review these expenses regularly. For example, you may have signed up to a free trial of a software, such as project management, CRM, or payroll software, that has expired and is now charging you monthly, so it’s important to review this to check you are getting what you want from the technology – and if not, it’s time to shop around.

Similarly, you may be able to find a cheaper utilities provider, or a better smartphone contract fee for your staff’s work phones, if you’re willing to switch providers.

Here is your checklist for lowering overhead costs:

• Check out the competitors of your usual suppliers
• Calculate whether buying in bulk could save you money
• Check that your monthly subscriptions are serving your needs – and that you aren’t signed up to any you’ve forgotten about, or that are rarely used
• Ensure your processes are time-saving and efficient to reduce excess labour and supply costs

Final thoughts

Keeping track of your overhead costs is essential to business success. Such costs can get out of control if left untracked, and that money could be used elsewhere to boost your business. Pop a monthly meeting in the diary with your finance team or accountant to review your overheads, and make it a non-negotiable get together.

Remember, while it may be time consuming, switching up those variable business overheads could save you significant money in the long run.

Kirstie Pickering - business journalist

Kirstie is a freelance journalist writing in the tech, startup and business spaces for publications including Sifted, UKTN and Maddyness UK. She also works closely with agencies to develop content for their startup and scaleup clients.