Overhead expenses are the costs of doing business that recur on an ongoing basis but that cannot be directly attributed to the production of a good or service. For example, the rent and utilities paid by a factory are considered overhead expenses because they are not directly tied to the manufacturing process. In contrast, the costs of raw materials and shop floor labour are considered production expenses because they are directly related to making the product.
Compile a list of all expenses that the business incurs regularly. That list should include categories for administrative salaries, office space and supplies, rent, taxes, financing costs, raw materials or goods for resale in a retail operation and production labour.
Review the list to determine which expenses occur as a direct result of producing a good or service and which expenses are only indirectly related. Indirect costs are considered to be overhead expenses.
Determine the amount or average of each overhead cost per month or another convenient time period. Add the monthly overhead costs to determine total monthly overhead expenses.
Divide the monthly overhead expenses by total monthly sales and multiply by 100 to find the overhead expenses as a percentage of sales volume. For example, if a factory has sales of £1.0 million per month and £292,500 in monthly overhead expenses, the calculation is ($450,000/$1,500,000) x 100 = 30 per cent.
Sometimes it may be difficult to determine whether a particular cost should be classified as an overhead expense. Don’t be discouraged by this reality. Your decision about how to classify certain expenses may end up being a judgment call. For this reason, the specifics of any stated overhead expense calculation should be clearly stated to avoid confusion.