The expenses a business incurs, as it operates, can be categorised as either direct or indirect costs. Direct costs are those closely linked to the actual production of goods or services. Any other expense is considered an indirect cost. The total of all indirect costs is considered overhead. Successful businesses keep track of overhead expenses and strive to keep them to a minimum. Lower overhead expenses translate into greater profit margins or the ability to offer lower prices. Either way, properly calculating and managing overhead expenses can confer a competitive advantage on a business.
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Identify direct costs for your business. Each type of business is different so the constituents of direct cost vary. Typically, direct costs include the cost of raw materials and production labour in manufacturing. In retail, inventory is a direct cost.
Compile a list of all other expenses the business regularly incurs. Examples include rent, utilities and interest on loans. Carefully review this list to determine if any items should be reclassified as direct costs.
Choose a convenient time period, such as one month, and add up all the expenses the business incurred during that period. Do the same for all direct costs.
Subtract the total direct costs for the period from total expenses. The remainder is your overhead expense. For example, if a business has total expenses for a month of £113,750 and direct costs of £68,250, overhead expenses are the difference between £113,750 and £68,250, or £45,500.
Express overhead expenses as a percentage of total expenses by dividing total expenses into overhead expenses and then multiplying by 100. For total expenses of £113,750 and overhead expenses of £45,500, you have ($70,000/$175,000) x 100 = 40 per cent.
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