How to Calculate Overhead in 3 Steps
Posted on February 07, 2019 by Danny Leffel
It’s crucial for restaurant owners to
What Are Overhead Expenses?
Before we jump into the calculation, we need to define overhead expenses. Essentially, they are the necessary and ongoing expenses a business incurs in order to keep running, regardless of whether the business is doing well or not. These expenses are not related to direct materials, direct labor, or third-party expenses that are billed to customers.
Businesses have two different types of overhead expenses: fixed and variable. Some examples of fixed overhead costs are rent, utilities, insurance, internet, property taxes, and salaries for administrative staff and management. These fixed costs are not impacted by the health of the business and will not change. Variable overhead costs will change depending on how much business is being done. Some examples include shipping, office supplies, legal fees, advertising, and maintenance expenses.
How to Calculate Your Overhead Expenses
Now that you know what constitutes an overhead cost, you’re ready to calculate it. Keep in mind that overhead expenses are typically calculated on a monthly basis.
1. List Your Business Expenses
Make a list of all of your expenses for a month so you can see what you’re spending money on. Try to make it as comprehensive as possible. If you’re unsure about the exact cost of something, just estimate.
2. Classify Each Expense
As stated above, not every expense you have will be considered overhead. If you’re unsure how to categorize something, ask yourself if you would still have the expense if your business hadn’t sold anything that month. If you don’t sell anything and still have the expense, the cost is probably overhead. For some expenses, you may find that a portion of the expense should be considered overhead but not the entire amount. In those cases, only include whatever percentage is part of your overhead cost.
Some items may not be clear-cut, so be consistent from period to period. Loan payments, for instance, can be tricky because they consist of two parts: the principle and the interest. The principle isn’t technically an expense, but if you’re trying to get an idea of how much money it takes to run your business, it might be a good idea to classify the complete loan payment as overhead.
3. Add Up Your Overhead Expenses
Total the items you classified as overhead costs. For this example, we’re using a monthly period, but you can use whatever time frame works best for your company. The amount you come up with is your total overhead expense for the period.
How to Track Your Overhead Expenses
Now that you know how to calculate your overhead, you’ll want to keep track of it over the next few periods to identify any areas where you can make cuts to save money. Management will sometimes have several people monitoring the different parts of overhead expenses, so communicating the amounts to each other is critical for good recordkeeping.
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The Importance of Knowing Your Overhead Expenses
If you know how much money it takes to run your business, you can factor it into your bottom line. You can set goals based on what your company needs to be profitable and create a plan to reach those goals. If you believe you’re spending too much money on expenses, take a look at your overhead and see where you can cut costs.
Oftentimes, you will find expenses that can be lowered (such as finding internet service from a more affordable provider, downsizing your floor space, or limiting the number of vehicle trips your employees take). The more you’re able to reduce your overheads costs, the higher your net profit will be.
Businesses are strongly affected by increases in expenses. Something as simple as yearly rent increases can jeopardize a restaurant’s chances at success. Keeping tight control of your overhead costs can reduce the likelihood that your business will fall victim to financial troubles.