OVERHEAD COST-

Overhead Costs Definition

Overhead costs are the continuous business expenses that are not directly related to
manufacturing a product or creating a service. It is an important part of the budgeting
process and also determines how much a company will charge for a product or service for
profit.

Simply put, an overhead meaning can be any expense a company incurs to support the
core business activities, while not being directly related to the business’ products and
services.

Overhead Costs Examples

An organization has to pay overhead on various fronts on a regular basis, irrespective of

the company’s sales.

For example, a business that offers services with an office has overhead costs, like rent,
insurance, utilities, office supplies, etc. These are in addition to the direct costs of
providing its services.

Some other overhead costs’ examples are:

1. Employee travel
2. Advertising expenses
3. Accounting and legal expenses
4. Salaries and wages
5. Depreciation
6. Government fees and licenses
7. Property taxes

The expenses that are related to overhead appear on an organization's income statement.

Overhead costs directly affect the growth of the business. Organizations must take
overhead costs into account for determining whether they are earning a profit or incurring
a loss.

Overhead costs for one organization may be a direct production cost for another
organization. For example, an advertising agency will likely list the expenses of a massage
session for its employees as an overhead cost, while the spa at which the said massage
session is happening will likely list it as a direct cost for providing the service.

Classification of Overhead

Source: Slide Player|Classification of overheads

Overhead costs can be classified in terms of functions, behavior, and elements.

When it comes to functions, overhead costs are categorized into the following types:

1. General and administrative overhead costs:

These generally include costs related to the overall management and administration of an
organization, like the need for accountants, human resources, receptionists, errand
runners, and other administrative staff.

2. Selling overhead costs:

These are related to activities that are a part of marketing and are fundamental to the
sales of the goods or services. It may include printed material and television
advertisements, as well as the commissions/incentives offered to the sales team.
Depending on the nature of the business, there can be other categories as well, like
research overhead, manufacturing overhead, maintenance overhead, warehousing
overhead, sales point overhead, or transportation overhead.

3. Production overheads:

These are incurred for production activities. Some examples would be electricity bills, raw
materials packaging, repair costs for machinery and, spare parts.

4. Distribution overheads:

These are required to deliver and transport products and services to customers. Some
examples of distribution overhead costs would be rent for godowns, packaging charges,
delivery vehicle fuel costs, etc.
Source: The Balance Small Business| Fixed vs variable costs

When it comes to behavior, overhead costs are categorized into the following types:

1. Fixed Overhead Costs:

These are those that remain the same amount every month. Fixed overhead costs do not
change with business activity. Fixed overhead costs can include rent, mortgage, utilities,
depreciation of assets, insurance, property taxes, annual salaries, and government fees.

2. Variable Overhead Costs:

These fluctuate according to business activity. When there is an increase in business

activity, variable overhead costs are likely to increase, too. Similarly, when there is a
decrease in business activity, variable overhead costs are likely to decrease. Variable
overhead costs may include shipping charges, legal expenses, office supplies, equipment
maintenance, materials, advertising,

Overhead costs are also classified in terms of the elements that are generating the cost. ie.
labor, materials or expenses.
1. Indirect Materials:

These lead to overhead costs because these materials are used in the production process,
but cannot be linked to a specific product or service. They are consumed as part of the
production process but are not integrated into major amounts into a product or service.
Some examples of the same would be fittings, cleaning supplies, oil.

2. Indirect Labor:

This is an overhead cost that is not directly related to the production of goods and the
delivery services, but adds to the production cost nonetheless. Some examples of indirect
labor costs would be the wages paid to executives for the transport of raw materials from
one warehouse to another.

3. Indirect Expenses:

These are those overhead costs that do not add any value to the production of goods,
and services, but are miscellaneous costs that aid the day-to-day activities of an
organization. Some examples of this would be postage, printing, research and,
development.

How to Calculate Overhead Costs

To calculate overhead costs, you can follow these steps:

1. List Expenses

The first step in decreasing overhead costs would be to make a comprehensive list of
indirect business expenses (items like rent, taxes, office equipment, factory maintenance,
utilities. etc.) These expenses do not affect the production process directly but add to the
overall expenses of production.
While categorizing the direct and indirect costs, we need to remember that some items
will not be attributed to a specific category.

2.  Add The Overhead Costs

Add the monthly overhead costs to calculate the aggregate overhead cost projections for
your organization on quarterly, half-yearly and, annual basis. This is the amount of money
that your company will need for running the business.
3. Calculate What The Overhead Rate Would Be

The overhead rate or the overhead percentage is the amount your organization spends
on manufacturing a product or providing services to their customers. To calculate the
overhead rate, we divide the indirect costs by the direct costs and multiply by 100.

For example: If the overhead rate is 20%, it means that the business spends 20% of the
revenue on manufacturing a good or providing its services. A lower overhead rate indicates
business efficiency and higher profits.
4. Compare To The Organization’s Sales

While setting prices and making the organization’s budgets, we need to know the
percentage of a dollar that is allocated to overhead costs. To calculate the percentage of
overhead costs in comparison to sales, we divide the monthly overhead cost by monthly
sales and multiply it by 100.

For example, if a business has a monthly sales of $150,000 and overhead costs are $45,000,
then overhead costs will be $45,000/ ($150,000) x 100 = 30%

5.Comparing To Labor Costs

If we want to measure the efficiency with which business resources are being used, we
calculate overhead costs as a percentage of the labor cost. The lower the percentage, the
more efficiently the business is utilizing its resources.

We divide the total overhead cost by the total labor cost for the month and multiply by
100 to express it as a percentage.

Example: Let us say that the overhead cost of a company is $1200 and the total labor cost is
$10,000. The labor cost percentage will be $1200/$10,000 x 100 = 12%

We hope this article cleared your doubts about overhead costs. If you want to simplify the
accounting process for your organization, Deskera is here to help. By using Deskera, you
will be able to automate accounting and inventory processes and keep your
organization’s health and processes in check. Not only that, you will be able to track your
company’s expenses and costs in real time, which will let you have more control over the
decision-making process.

LABOUR COST-
Labor Costs Definition
The labor costs definition is the total cost of all labor used in a business. It is one of
the most substantial operating costs. These are particularly important in
any business which experience heavy human resource labor
costs: construction, manufacturing, and other industries which have partially or
non-automated operations. These costs include 2 main subcategories. The direct
labor costs definition is summarized as the cost of labor which is used directly to
make products. Meanwhile, the indirect labor costs definition is simply explained
as the cost of labor which is used to support or make direct labor more efficient.

These costs are explained by many as the most important cost a company will face,

is a key factor in almost any business. This is due to the fact that employee
turnover is one of the main factors which causes a business to fail. To begin, it is in
the best interest of any owner that unit labor costs and inflation are minimized
to maximize profits.

The importance of labor costs does not stop here. They are a variable cost. As
such, they must also occur in a predictable cycle to avoid cash flow problems. If a
firm is seasonal and requires additional labor at peak
times, business controllers must have the cash on hand to afford this increase in
cost. If a business plans properly it will avoid many cash issues associated with the
cost of labor.

Labor Costs Formula

A single formula will not serve the many different needs associated. Despite this, a
common and simple formula is included below:

Labor Costs = (total sales x labor %) / average hourly rate of labor

Labor Costs Calculation

To perform a simple labor costs calculation follow the process outlined below:

If:
Total Sales = $1,000,000
Labor % = 15%
Average hourly rate of labor = $10

Labor Costs = ($1,000,000 x .15) / $10 = (150,000) / $10 = $15,000

Labor Costs Example

For example, Leann is the owner of a clothing store in the largest mall in her city.
Leann, a fashion aficionado from birth, knows the popular styles better than any
designer in Milan. She works diligently to make sure her store stays in pace with
the trends of today as well as the future.

Leann is gearing up for her peak season. Additionally, she is concerned because
her off-season sales have slumped slightly. She sees the new season as a
great opportunity to move inventory and regain the ground. That is, if she has
enough cash to get by.

Leann will need to increase hours for sales and backroom staff during these peak
times. To balance that, she will also have to make sure she can pay for
these employees. The slump in her off-peak season has made Leann plan more for
the future. She now wants to calculate cost of labor for her peak period to make
sure she can afford the cash needed to get by.

Leann performs this simple calculation to find her cost of labor:

If:
Total Sales = $1,000,000
Labor % = 15%
Average hourly rate of labor = $10

Then:
Labor Costs = (total sales x labor%) / average hourly rate of labor
Labor Costs = ($1,000,000 x .15) / $10 = (150,000) / $10 = $15,000

For Leann’s retail business cost of labor total $15,000 for the period she is
studying. This is more than she expected and can afford. Luckily, Leann has
excellent credit. Leann decides to apply for a small business loan to help
her company survive the first month of peak demand. From here she will make the
cash necessary to continue.

Leann also decides to pay more attention to her company finances. She was not
surprised by this situation, but still wants to be able to predict the problems that
her business will face better. Her drive and insight will achieve this and many
future goals.