How to Calculate Overhead Cost: Formula, Examples, and Ways to Reduce It

To calculate your overhead cost, add up every business expense that isn't tied to a specific job — rent, insurance, vehicle payments, office staff, software — then divide that total by your sales for the same period and multiply by 100. That gives you your overhead rate: the share of every dollar you earn that goes to just keeping the doors open. According to the Bureau of Labor Statistics, roughly 1 in 5 new businesses fail within their first year and about half within five years — and unmanaged overhead and the cash flow problems it causes are a common culprit. You'll never eliminate overhead entirely, but once you know your number, you can cut the expenses that aren't earning their keep and price every job so overhead is covered before profit is counted.

What Are Overhead Costs?

Overhead costs, also known as recurring expenses, keep your business running but do not add to revenue. These expenses are frequently referred to as indirect costs because they are not part of business operations that generate revenue and boost net profit. Overhead costs are categorized into three types: fixed overhead costs, variable overhead costs, and semi-variable overhead costs.

1. Fixed overhead costs

Fixed overhead expenses remain constant every month. Here are some examples:

• Payments for rent or mortgage
• Insurance premiums
• Taxes on real estate
• Software subscriptions and license fees

2. Variable overhead costs

Business operations influence variable overhead costs. These types of overhead costs rise in accordance with increased business operations. Variable overhead expenses include the following:

• Shipping
• Materials
• Advertising
• Maintenance of office equipment

3. Semi-variable overhead costs

Semi-variable overhead costs vary significantly from month to month based on usage. These are some examples of overhead costs:

• Utility bills
• Salaries (including overtime)
• Business vehicle usage
• Maintenance and repairs of tools and equipment

When calculating overhead costs, these categories become less significant. However, understanding the differences is critical to the functioning of your organization.

Importance of overhead costs

Based on your business operations, overhead expenses make up a big amount of dollars bills that you spend every month. Understanding and managing them properly might play a crucial part and make a difference in your company's profit and loss.

Now that you know what overhead costs are and why they are significant, let's move on to understanding how to calculate and reduce them.

How to Calculate Overhead Cost?

To determine your overhead costs, follow the steps discussed below:

For a service business, it also helps to know your overhead cost per billable hour, so you can build it into every estimate. Divide monthly overhead by the billable hours your crew actually works — not the hours they're on the clock.

Why Are Reducing Overhead Costs Important?

Overhead never contributes to generating sales — that's why it's called an indirect cost. Every dollar you trim from it, though, drops straight to your bottom line: cutting $500/month in overhead has the same effect on profit margin as winning roughly $1,000/month in new revenue at a 50% gross margin, without doing a single extra job.

When you cannot remove the indirect costs, you can surely cut the non-essential indirect expenses by following certain techniques.

Ways to Reduce Overhead Costs

1. Hire an accountant or bookkeeper

An accountant or bookkeeper will categorize your expenses correctly, catch deductions you'd miss, and prevent the financial mistakes that cost far more than their fee. If you're not ready to hire one, at least get your small business accounting basics in order so your overhead numbers are trustworthy.

2. Have a Deep Dive into your Overhead Costs

Review your overhead costs at regular intervals — quarterly works for most small businesses. Each review, sort every indirect expense into "essential" and "not earning its keep": the second list is where subscriptions you forgot about, redundant insurance riders, and underused equipment leases hide, and eliminating them reduces your total overhead cost without touching operations.

3. Trim the Staff Count

Downsizing is often a preferred alternative, particularly if you've discovered that you can lower the number of employees without affecting productivity or efficiency.

4. Outsource Few Duties

It is not always important to find everything in-house. Specific responsibilities can be outsourced to help you replace staff shortages without needing to pay full-time compensation. It also means you'll save money on office supplies and other overhead costs.

5. Right-size your software and equipment

Instead of buying pricey software suites or the latest equipment models, purchase licenses only for the employees who need them, and question every renewal. If you're in construction or the trades, there are more ideas for cutting shop and equipment overhead specific to your world.

6. Go Green

If you're not careful, your utility expenses can quickly add up.

7. Go Paperless

Stop paying for printing, paper, ink, and postage. Digital estimates and invoices cost nothing to send, can't get lost in a truck cab, and get to your customer the moment the job is done.

Scale Your Business with InvoiceOwl!

Now that you know how to calculate your overhead costs, make it a habit: total them monthly, track your overhead rate over time, and build the number into every estimate you send. Overhead can't be eradicated fully — some of it is simply the cost of being in business — but knowing your rate is the difference between jobs that look profitable and jobs that actually are. Software like InvoiceOwl streamlines your estimating and invoicing with automation, helping you save the time and paperwork costs that quietly pad your overhead. Start your free trial today and see the difference for yourself.