OVERHEADS meaning and definition

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What Does "Overheads" Mean in Business?

In the world of business, finance, and accounting, there are many terms and concepts that can be confusing to those who are new to the field. One such term is "overheads." In this article, we will delve into what overheads mean, how they are calculated, and their importance in business decision-making.

What Are Overheads?

In simple terms, overheads refer to the costs or expenses that a company incurs in order to operate its business. These expenses are not directly related to the production of goods or services but are necessary for the day-to-day functioning of the organization. Examples of common overheads include:

Rent and utilities for office space
Salaries and benefits for administrative staff
Insurance premiums (e.g., liability, property)
Depreciation and amortization of assets (e.g., equipment, software)
Taxes and fees (e.g., business license, permits)

How Are Overheads Calculated?

Overheads can be calculated using one of two methods: direct method or indirect method.

Direct Method: This approach involves identifying the total overhead costs and then allocating them to each product or department based on their usage. For example, if a company has 10 employees working in an administrative department, and the total overhead cost for that department is $50,000 per year, then each employee's share of those overheads would be $5,000 per year.
Indirect Method: This approach involves calculating the total overhead costs as a percentage of the total direct labor costs or total sales revenue. For example, if a company has total direct labor costs of $100,000 and total overhead costs of $20,000, then the overhead rate would be 20% ($20,000 ÷ $100,000).

Why Are Overheads Important?

Overheads are important for several reasons:

Profitability: Knowing your overheads is crucial in determining your company's profitability. If you don't account for overheads, you may overestimate your profits or underestimate your losses.
Budgeting: Overheads help you create a realistic budget for your business. By accounting for these expenses, you can ensure that you have enough funds to cover your operational costs.
Decision-Making: Understanding your overheads enables informed decision-making when it comes to investments, pricing strategies, and resource allocation.

Conclusion

In conclusion, overheads are an essential part of a company's financial landscape. By understanding what overheads mean and how they are calculated, business owners and managers can make more informed decisions about their operations, budgeting, and profitability. Whether you're a small startup or a large corporation, knowing your overheads is key to ensuring the long-term success of your business.

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