How to Calculate Overheads for Your Small Business

Figuring out your overheads might sound complicated, but it’s simpler than you think. In a nutshell, you just add up all the indirect costs—things like rent, software subscriptions, and utilities—that keep your business running but aren’t tied directly to one specific client project. Getting a handle on this number gives you a crystal-clear picture of your baseline operating costs, which is absolutely essential for setting profitable prices and making smart financial moves.

Why Overheads Are Your Business’s Hidden Engine

Before we jump into the formulas, let’s take a moment to reframe how we think about overheads. It’s easy to see them as just a necessary evil—a long list of bills you have to pay every month just to keep the lights on.

But in reality, they’re the hidden engine of your business. These are the costs that support every single project, every client relationship, and every deliverable you produce. Your team’s talent is what creates the value, sure, but your overheads create the environment where that value can actually happen.

The Foundation of Profitability

Without a solid grip on these background costs, you’re essentially flying blind. You might feel busy and keep billing clients, but are you actually profitable? Getting your overheads straight is the very first step toward real financial clarity.

It empowers you to:

• Price with confidence: Knowing your overheads means every quote you send is built on a foundation of real costs, not just a gut feeling.
• Budget effectively: You can build realistic financial plans and forecasts that account for all your expenses, which helps prevent those nasty cash flow surprises.
• Make smarter decisions: Wondering if you can hire a new team member or invest in that new software? It becomes a calculated choice instead of a gamble.

Overheads aren’t just expenses to be minimized at all costs. They are investments in your operational capacity. When you manage them wisely, they directly contribute to your company’s stability and growth potential.

Turning Costs into a Strategic Tool

Here’s a practical example. A small marketing agency might look at its $2,000 monthly software subscription and see it as a hefty expense. But when they dig deeper, they realize this tool saves each team member five hours a week on tedious admin tasks.

Suddenly, that subscription isn’t just a cost; it’s an investment in efficiency that frees up more billable hours for client work.

It’s the same for your office rent. That cost provides a collaborative space that sparks creativity and strengthens your company culture. The salaries for your admin team? They ensure projects run smoothly and clients stay happy.

When you learn how to calculate overheads properly, you’re not just doing accounting. You’re gaining strategic insight into the operational health of your business. This perspective shifts overheads from being a burden into a powerful tool for building a more resilient and profitable company.

Finding and Organizing Your Overhead Costs

Before you can even think about plugging numbers into a formula, you need to know what those numbers are. This means putting on your detective hat and rounding up every single one of your business’s indirect costs.

An accurate overhead calculation is built on good data, plain and simple. Your mission is to hunt down every expense that keeps the lights on but isn’t directly tied to a client project.

The best place to start your search is in your primary financial records. Dig into your accounting software, comb through your business bank and credit card statements, and pull up your payroll records. These documents hold all the clues. Of course, a dedicated platform can make this a whole lot easier; good time tracking and expense software, for example, can categorize many of these costs for you automatically.

Sorting Your Expenses Into Categories

As you start gathering your expenses, you’ll see they don’t all behave the same way. Some are steady and predictable, while others bounce around from month to month. To get a truly accurate picture, you’ll want to sort them into three main buckets.

• Fixed Costs: These are your predictable, recurring expenses. They stay the same no matter how busy you are. Think of your monthly office rent or that flat-rate software subscription—you pay the same amount whether you’re slammed with client work or experiencing a quiet spell.
• Variable Costs: These costs fluctuate with your business activity. For a service firm, this could be things like office supplies or utility bills that creep up when the team is pulling longer hours to hit a big deadline.
• Semi-Variable Costs: This is the hybrid category. These costs have a fixed base amount plus a variable component that changes with activity. A classic example is a salesperson’s compensation—they get a fixed base salary plus a commission that depends on how much they sell.

Your goal here is to turn a messy pile of receipts and invoices into a clean, organized list. When you categorize each expense, you’re not just prepping for a calculation; you’re gaining a much clearer understanding of your company’s entire financial DNA.

To help you get started, here’s a quick breakdown of common overhead expenses and how they typically fall into these categories.

Categorizing Your Overhead Expenses

Expense Category	Example Expenses	Cost Type (Fixed/Variable/Semi-Variable)
Administrative & Office	Rent, utilities, property taxes, office supplies, cleaning services, equipment maintenance	Fixed, Variable, Semi-Variable
Salaries & Benefits	Administrative staff salaries, HR personnel, management salaries, employee benefits	Fixed, Semi-Variable
Technology & Software	CRM, project management tools, accounting software, communication platforms (e.g., Slack)	Fixed
Professional Services	Legal counsel, accounting and bookkeeping fees, external consultants	Fixed, Variable
Insurance	General liability, professional indemnity, workers’ compensation, property insurance	Fixed
Marketing & Business Development	Advertising campaigns, social media management, website hosting, content creation	Variable, Semi-Variable

This table isn’t exhaustive, but it’s a solid starting point for making sure you don’t miss anything obvious. Use it as a checklist to methodically work through your own business’s spending.

A Checklist of Common Overheads

To make sure nothing slips through the cracks, it helps to have a checklist. From an accounting perspective, you’re essentially combining all indirect materials, labor, and other miscellaneous expenses.

For a tangible example, let’s imagine a small graphic design agency. Their monthly overheads look like this:

• Rent for their studio space: $5,000 (Fixed)
• Utilities (internet, electricity): $1,200 (Variable)
• Administrative assistant’s salary: $3,800 (Fixed)

Their total monthly overhead would come out to $10,000.

Here are some of the most common overheads you’ll want to look for:

• Office Rent and Utilities: This bucket includes electricity, water, gas, and your internet service.
• Salaries and Benefits: Be sure to include only non-billable staff here—think administrative assistants, office managers, or marketing coordinators.
• Software Subscriptions: All those tools you rely on, like your CRM, accounting software, and project management platforms.
• Professional Fees: This covers any money you pay out for legal services, accounting fees, or specialized consulting.
• Insurance: Don’t forget liability, property, and workers’ compensation insurance. They’re all overheads.
• Marketing and Advertising: Any costs related to campaigns, social media management, and creating promotional materials fall in here.
• Office Supplies and Equipment Maintenance: This includes regular purchases of supplies as well as any repairs needed for office equipment.

Calculating Your Overhead Rate

Once you’ve tallied up your total overhead costs, you’ve already done half the heavy lifting. Now, it’s time to turn that raw number into one of the most powerful metrics for your business: the overhead rate. This simple percentage tells you exactly how much operational cost is packed into every dollar you spend on labor or every hour your team works.

Think of it this way: for every dollar you spend directly on a project (like a developer’s salary), the overhead rate tells you how many extra cents you need to tack on to cover rent, software, and admin support. Nailing this is the key to pricing your services for real, sustainable profit.

The core formula is pretty straightforward:

Total Monthly Overheads / Total Monthly Allocation Base = Overhead Rate

The “allocation base” is just the yardstick you use to apply these overheads to your projects. It’s the engine of the whole calculation.

Choosing Your Allocation Base

Honestly, the trickiest part of figuring out your overheads is often just picking the right allocation base for your business. The goal is to choose a measure that logically links your background costs to the actual work you produce.

For most professional services firms, it boils down to one of these:

• Direct Labor Costs: This is usually the most accurate method for consultancies, agencies, and architecture firms. It ties overheads directly to your single biggest project expense—your team’s salaries.
• Direct Labor Hours: This is similar, but it uses the total number of billable hours your team works instead of the dollar cost. It’s a great fit for businesses that primarily bill by the hour.
• Sales Revenue: While this method is simpler, it can sometimes be less precise. It calculates your overheads as a straight percentage of your total sales.

Choosing the right allocation base is crucial. If your business is labor-intensive, tying your overhead rate to direct labor costs gives you a far more accurate picture of project profitability than using a broad metric like total sales revenue.

The flow—from gathering documents to sorting costs and creating a final list—is the essential groundwork you need to do to calculate an accurate rate.

A Practical Example: A Local Bakery

Let’s make this real with a quick example. Imagine a local bakery has $10,000 in total monthly overheads (rent, utilities, admin staff). In that same month, the bakery’s direct labor costs for its bakers—the team actually making the products—totaled $20,000.

Using the direct labor cost method, the calculation is simple:

$10,000 (Total Overheads) / $20,000 (Direct Labor Costs) = 0.50

To get a percentage, just multiply by 100. So, the bakery’s overhead rate is 50%.

What does this mean in the real world? It means for every $1.00 the bakery spends on its bakers’ salaries, it has to add an extra $0.50 to the price of its products just to cover all those indirect expenses. This single number ensures every croissant and cupcake sold contributes its fair share toward keeping the lights on and the business running smoothly.

Choosing the Right Allocation Method

Think about a marketing agency and a manufacturing plant. Their day-to-day operations are worlds apart, right? It makes sense, then, that the way they handle overheads should be different, too. A one-size-fits-all approach to allocating these costs just doesn’t cut it. The method you choose has to reflect how your business actually uses its resources if you want a true picture of your profitability.

Picking the right allocation method is less about complicated accounting theory and more about common sense. You’re looking for a logical link between your overheads (like rent and software) and the actual work that brings in revenue. This choice directly shapes how you calculate overheads and, ultimately, how accurately you price your services.

Traditional vs Modern Approaches

For decades, many businesses kept things simple. A classic and widely used method involves applying a single, predetermined rate based on direct labor hours or direct labor costs. This was perfect for manufacturing companies back when production was heavily labor-intensive.

But as technology and automation became the norm, tying everything to direct labor started to feel a bit outdated. It was no longer a good proxy for how resources were actually being consumed. This exact shift prompted companies like Chrysler to adopt more nuanced methods all the way back in 1991, which you can read about in this overview of traditional allocation methods on OpenStax.org.

This evolution highlights a crucial point: your allocation method needs to adapt as your business does.

The goal isn’t just to spread costs around. It’s to do so in a way that accurately reflects the real cost of delivering a service. An inaccurate method can lead to poor pricing decisions, making some projects seem far more profitable than they truly are.

Activity-Based Costing (ABC)

One of the more precise, modern methods is Activity-Based Costing (ABC). Instead of using a single, company-wide rate, ABC breaks down your overheads into different activities and assigns their costs based on actual consumption. It recognizes that not all projects use resources in the same way.

Let’s take a design agency with two main services: quick logo designs and massive brand strategy projects.

• Logo Designs: These are fast, mostly involving a designer’s time. They don’t require much project management or client hand-holding.
• Brand Strategy: These are complex, multi-month projects. They demand significant input from project managers, account executives, and senior leaders, not to mention more software resources.

Using a simple direct-labor allocation, both services might get saddled with the same overhead percentage. But with ABC, you can create different “cost pools” for activities like project management or client services. You then assign those costs more heavily to the brand strategy projects that actually use them. This gives you a far more accurate view of each service’s true profitability.

For a deeper dive into how this plays out in practice, check out our guide on how to integrate project management and accounting.

Ultimately, picking the right method means taking an honest look at your operations. For many professional services firms, using direct labor cost remains an excellent and simple starting point. But if your services have wildly different resource needs, exploring a method like ABC can uncover powerful insights and reveal hidden opportunities for savings and growth.

Turning Overhead Data Into Action

Knowing your overhead rate is a fantastic start, but that number isn’t just for plugging into pricing quotes. It’s a powerful tool for making smarter, more strategic decisions that can directly fuel your business’s growth.

The real magic happens when you move from simply knowing the data to actively using it to manage and reduce your overheads over time. This means shifting from a once-a-year calculation to a regular financial check-in. Think of it as a monthly health check for your business.

By comparing your actual overhead spending against your budget each month, you can catch small issues before they become big problems and spot positive trends you can build on.

From Historical Data to Future Forecasts

One of the most valuable things you can do with your overhead data is use it to predict the future. By analyzing your past expenses, you can create much more accurate forecasts for upcoming projects and financial periods. This proactive approach is a game-changer, especially in industries where margins are tight.

The construction industry offers a great model for this. Recent analysis shows that a contractor’s historical data is key to forecasting new project overheads based on factors like size, duration, and complexity. The process includes monthly monitoring of actual costs against estimates to prevent overruns. You can find more insights about overhead estimation in construction on ASCE Library39).

This same principle applies to any professional service. Looking back at a year’s worth of utility bills or software fees helps you budget more intelligently for the year ahead. Simple, but incredibly effective.

Your overhead data isn’t just a record of what you’ve spent; it’s a roadmap for where you’re going. Using it to forecast helps you allocate resources effectively and maintain profitability, even when facing unexpected challenges.

Spotting Your Cost-Saving Opportunities

Regularly reviewing your overheads also puts you in the perfect position to identify concrete opportunities to save money. This doesn’t have to mean making huge, disruptive changes. Often, the biggest wins come from small, consistent adjustments.

Start by looking for quick wins in these areas:

• Software Subscriptions: Are you paying for tools your team no longer uses? Many companies find they have redundant or underutilized software. A quick audit can often lead to immediate savings.
• Supplier and Vendor Contracts: When was the last time you renegotiated with your insurance provider or office supply vendor? It never hurts to ask if there’s a better rate available.
• Utility Usage: Simple changes, like switching to energy-efficient lighting or encouraging staff to power down equipment at night, can add up to significant savings over a year.

By turning these small actions into regular habits, you transform smart expense management from a one-time project into a real competitive advantage. And when you have all this information organized in one place, it’s so much easier to maintain your firm’s overall financial performance and make data-driven decisions confidently.

Common Questions About Overhead Costs

As you start getting a handle on overheads, it’s natural for a few questions to pop up. This isn’t just abstract accounting; it touches so many parts of your business, so a little confusion is completely normal. Let’s clear up some of the most common queries we hear from business owners.

How Often Should I Calculate My Business Overheads?

This is a fantastic question because consistency is everything here. For good financial hygiene, you should be calculating your total overhead costs every single month.

This rhythm lets you spot trends, manage your cash flow, and catch any surprise expenses before they blow up. Just think of it as a non-negotiable part of your regular monthly financial review.

But what about your overhead rate—the percentage you use for pricing and project costing? That doesn’t need to be updated quite as often. For most professional services businesses, recalculating this on a quarterly or even annual basis is perfectly fine.

The big exception? When something significant changes. If you move to a pricier office, hire a new administrative team member, or invest in expensive new software, it’s time to rerun the numbers immediately.

Your monthly calculation is for monitoring your business’s health and cash flow. Your quarterly or annual rate update is for ensuring your pricing strategy remains profitable and accurate.

What Is the Difference Between Overheads and COGS?

This is one of the most important distinctions in business accounting, and thankfully, it’s simpler than it sounds. The key difference is whether a cost is directly or indirectly tied to delivering your service.

• Cost of Goods Sold (COGS): These are the direct costs of production. For a marketing agency, this would be the salary of the graphic designer working directly on a client’s campaign. For an architecture firm, it’s the wages of the draftsperson drawing up the plans.
• Overheads: These are all the indirect costs required to keep the lights on and the business running. This includes the rent for the office, the subscription for your project management software, and the salary of the office manager who supports everyone.

Why does this matter so much? Separating the two allows you to calculate your gross profit (Revenue - COGS) and your net profit (Gross Profit - Overheads), giving you a much clearer picture of where your money is really going.

Can I Have Zero Overhead Costs in My Business?

In a word: no. It’s nearly impossible for any real business to have absolutely zero overhead.

Even a solo freelancer working from their home office has indirect costs. That monthly internet bill, the subscription to Adobe Creative Cloud, and even a portion of the home’s utility bills are all legitimate overhead expenses.

The goal isn’t to completely eliminate overheads—that’s unrealistic. The real objective is to understand them, manage them wisely, and ensure your pricing structure is robust enough to cover them profitably.

When you know exactly what your overheads are, you can make sure every project you take on contributes its fair share. That’s how you build a stronger, more financially resilient business.

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