Overhead definition

Overhead is those costs required to run a business, but which cannot be directly attributed to any specific business activity, product, or service. Thus, overhead costs do not directly lead to the generation of profits. Overhead is still necessary, since it provides critical support for the generation of profit-making activities. For example, a high-end clothier must pay a substantial amount for rent (a type of overhead) in order to be located in an adequate facility for the sale of clothes. The clothier must pay overhead to create the proper retail environment for its customers. Examples of overhead are:

  • Accounting and legal expenses

  • Administrative salaries

  • Depreciation

  • Insurance

  • Licenses and government fees

  • Property taxes

  • Rent

  • Utilities

Overhead costs tend to be fixed, which means that they do not change from period to period. Examples of fixed overhead costs are depreciation and rent. Less frequently, overhead varies directly with the sales level, or varies somewhat as the activity level changes.

The other type of expense is direct costs, which are those costs required to create products and services, such as direct materials and direct labor. Overhead and direct costs, when combined, comprise all of the expenses incurred by a company.

A business should set its long-term product prices at levels that account for both its overhead costs and direct costs. Doing so allows it to earn a profit on a long-term basis. However, it is is possible to ignore overhead costs for the pricing of special one-time deals, where the minimum price point only has to exceed the relevant direct costs.

Similar Terms

Overhead is also known as burden or indirect costs. A subset of overhead is manufacturing overhead, which is all overhead costs incurred in the manufacturing process. Another subset of overhead is administrative overhead, which is all overhead costs incurred in the general and administrative side of a business.

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