What are business overheads?

Published Monday 8 June 2026

Table of contents

• What are business overheads?
• Types of overhead costs
• Administrative vs manufacturing overheads
• Common examples of overhead costs
• Why overheads in business can be confusing
• Other categories of business expenses
• How to calculate overhead costs
• Tips for reducing business overheads
• The risks of cutting overheads too deeply
• How overheads affect the bottom line
• Why you should regularly review and adjust overhead costs
• Track and manage your overheads with Xero
• FAQs on business overheads

Key takeaways

• Business overheads are the indirect costs of running your business that aren't directly tied to producing goods or delivering services, such as rent, insurance, and utilities.
• Understanding the difference between fixed, variable, and semi-variable overheads helps you budget more accurately and spot opportunities to cut costs.
• Calculating your overhead rate lets you set prices that cover all your costs, so you can protect your profit margins and avoid undercharging.
• Regularly reviewing your overheads, ideally monthly or quarterly, keeps your spending in check and helps your business stay resilient during tougher times.

What are business overheads?

Business overheads are the ongoing costs of running your business that aren't directly tied to producing a specific product or delivering a particular service. These are also known as indirect costs. If a cost is incurred to create a product or deliver a service, it's classed as a direct cost, not an overhead.

Common examples of overhead costs include rent, insurance, utilities, and administrative salaries. Every business has overheads, regardless of size or industry. Understanding what they are and how to manage them is essential for protecting your profit margins.

Types of overhead costs

There are three main types of overhead costs: fixed, variable, and semi-variable. Knowing which category your costs fall into helps you plan your budget and anticipate changes.

Fixed overheads

Fixed overheads are costs that stay the same regardless of how much your business produces during a set period. Examples include your office rent, insurance premiums, and the salaries of administrative employees. These costs are predictable, which makes them easier to budget for.

Variable overheads

Variable overhead costs fluctuate depending on your business activity. For instance, you might spend more on shipping materials, marketing, or office supplies during busy periods. When sales slow down, these costs typically decrease too.

Semi-variable overheads

Semi-variable overhead costs have both a fixed and a variable component. You can't avoid them entirely, but they'll rise during your busier periods. For example, your phone plan might have a base monthly charge plus extra fees for additional usage. Utility bills often work the same way, with a standing charge plus usage-based costs on top.

Administrative vs manufacturing overheads

Overhead costs can also be grouped by the part of your business they support. The two most common categories are administrative overheads and manufacturing overheads.

Administrative overheads cover the costs of running your office and managing the business. These include office rent, insurance, office supplies, management salaries, and accounting fees. Most service-based businesses will find that the majority of their overheads fall into this category.

Manufacturing overheads, on the other hand, relate to the costs of running a production facility that aren't directly tied to making a specific product. Examples include factory rent, equipment depreciation, supervisor salaries, and factory utility bills. If your business produces physical goods, it's important to separate these from your administrative overheads so you can accurately cost your products.

Common examples of overhead costs

Overhead costs vary from one business to the next, but certain expenses crop up across most industries. Here are some of the most common overhead costs you're likely to encounter.

• Rent and property costs: Whether you lease an office, a shop, or a warehouse, rent is typically one of your largest fixed overheads. Property-related costs like building insurance and security also fall into this category.
• Insurance: Business insurance, employer's liability insurance, and professional indemnity insurance protect your business but represent ongoing overhead costs.
• Utilities: Electricity, gas, water, internet, and phone bills are essential for keeping your business running day to day.
• Employee perks and benefits: Costs like pension contributions, health benefits, team lunches, and staff training support your team but aren't directly tied to production.
• Repairs and maintenance: Keeping your premises, equipment, and technology in good working order is an ongoing overhead that's easy to overlook until something breaks.
• Professional services: Fees for accountants, solicitors, consultants, and other professional advisors are common overhead costs for small businesses.

Why overheads in business can be confusing

Overheads can be confusing because each business determines what counts as an overhead in a different way. It's often assumed that fixed costs are indirect (and therefore an overhead) because you have to pay them whether you produce anything or not. Similarly, variable costs are often assumed to be direct, and therefore not an overhead. However, it isn't always that clear cut.

For instance, how you classify rent depends on what it's used for. Some businesses might count rent as a cost of production, for example factory rent, which would make it a fixed direct cost and not an overhead. Others might classify their rent as a fixed indirect cost, such as an office building the business pays for whether or not it's open, making it a fixed overhead.

How you classify your overhead costs will depend on your type of business and how it's structured. Grouping your costs into categories during your small business accounting, for example manufacturing, admin, and development costs, can help streamline this process. You'll then be able to calculate how much you're spending on overhead costs versus production more easily.

The key thing to remember is that overheads are indirect costs: they're not directly related to producing your goods or services, and they can be fixed, variable, or semi-variable.

Other categories of business expenses

Overhead expenses are just one category of business costs. To avoid confusion, it helps to understand the other main categories and use them in the correct contexts.

• Cost of goods sold (): These are direct costs tied to producing your goods or services.
• Selling, general, and administrative (SG&A): These are operational costs not directly linked to production, such as marketing and office expenses.
• Depreciation and amortisation: This accounts for the decrease in value of your assets over time.
• Interest: The costs associated with borrowing funds.
• Income taxes: The taxes on your business earnings.
• Miscellaneous: Small, irregular expenses that don't fit neatly into other categories.

How to calculate overhead costs

Calculating your overhead costs helps you understand the true cost of running your business. Follow these steps to work out your overhead rate.

1. Identify your overhead expenses

List all of your overhead expenses, including fixed, variable, and semi-variable costs, that relate to the same product or service. To get a more detailed picture, you can allocate overhead costs to specific areas using activity-based costing.

2. Choose your allocation measure

The allocation measure is any type of measurement that's necessary to make the product or service. This could be the total of any direct costs involved in production, such as direct labour, machine, or material costs. It could also be the direct labour or machine hours it takes to create your product.

3. Apply the overhead rate formula

Divide your total indirect costs by your allocation measure to find the overhead rate:

Overhead rate = indirect costs / allocation measure

Overhead costs calculation example

Here's an example of how to calculate your business overhead costs.

Let's say your company has overhead expenses that come to €10,000 for the latest financial period and you want to know how overhead costs relate to labour costs. Within this same period, you had labour costs amounting to €2,500.

To find the overhead rate, divide €10,000 (indirect costs) by €2,500 (direct costs), which equals four.

In other words, every euro you spend on labour costs your business four euro in overhead expenses. This kind of insight helps you price your products or services more accurately.

Tips for reducing business overheads

Regularly reviewing your overheads, and reducing costs where necessary, plays a key role in financial planning. Try these cost reduction techniques to find some savings.

• Negotiate with suppliers and service providers: There's often savings to be had within existing supply chains, particularly if contracts haven't been revised for a while. Find out whether there's room for negotiation with your existing suppliers, and check their competitors' prices.
• Consider remote or shared workspaces: The normalisation of remote and flexible working has opened up opportunities for some businesses to cut overhead expenses. Instead of paying for a semi-empty office, investigate whether you could share an office with another company, look at co-working spaces, or consider setting up a mobile office.
• Use smart technology: Plenty of tools can automate tasks, saving you time and money. For instance, accounting software can help streamline your financial practices, and cloud accounting automates data entry.
• Monitor expenses closely: Keeping a close eye on your business expenses and employing efficient expense management ensures your profits aren't frittered away on unnecessary purchases. Xero's expense tracking tools give you the oversight you need.

The risks of cutting overheads too deeply

While reducing overheads is important, cutting too aggressively can do more harm than good. It's worth taking a balanced approach so you don't undermine the things that keep your business running well.

Slashing costs in areas like staff benefits, training, or equipment maintenance can affect the quality of your products or services. Over time, this may lead to higher staff turnover, lower morale, and a weaker reputation with customers. Retaining talented employees often depends on offering competitive perks and a positive working environment.

Cutting costs with suppliers can also backfire if it damages those relationships. Pushing too hard on price may result in longer lead times, lower-quality materials, or suppliers choosing to prioritise other clients. The goal is to find savings without sacrificing the foundations your business depends on.

How overheads affect the bottom line

To clearly understand your business's finances, you'll need to include your overhead expenses on your profit and loss statement. Understanding your financial statements is essential for getting the full picture. Overhead costs are taken from your net revenue, along with all your production-related costs, to reach your net income, also known as the bottom line.

High overheads will eat into your net income, reducing your overall profit. Your business will then be less able to invest in itself and grow, so keeping a tight handle on overhead expenses is essential.

When setting your product or service prices, you should factor in both your production costs and your overhead expenses to make sure you're making a profit. Not including overheads in this equation could mean your product is underpriced, reducing your potential profit margins.

You can analyse your stock management and see your most (and least) profitable lines with Xero inventory software.

Why you should regularly review and adjust overhead costs

Staying on top of your overhead expenses means reviewing them regularly for potential savings and avoiding financial pitfalls, like consistently negative cash flow.

Rising costs are a pressing concern for small businesses everywhere. Keeping a close eye on your overheads is one of the most practical steps you can take to stay ahead of cost pressures.

Implementing a monthly or quarterly review process, supported by a reliable cash flow forecast, can help you keep overhead costs in check. Look at each expense and ask whether it's essential, whether you could get a better rate, or whether it's a "nice-to-have" that could be paused during leaner periods.

Monitoring your overhead ratio, the percentage of your turnover that goes towards overheads, is a useful way to track progress over time. If this ratio starts creeping up, it's a signal to investigate and take action before it affects your cash flow.

Not fully accounting for overhead expenses can leave your business vulnerable to economic challenges, with less emergency funds to draw on. Day to day, high overheads make it difficult to sustain positive cash flow, which over time could result in downsizing or business closure. Including overhead management as part of your cost control strategies is important to keep your business not just afloat, but thriving.

Find out more about budgeting and financial forecasting.

Track and manage your overheads with Xero

Managing your overheads doesn't have to be complicated. With the right tools, you can track every expense, spot trends early, and make confident decisions about where to cut costs and where to invest.

Xero's cloud-based accounting software can help you track overhead expenses, manage stock, and monitor the financial health of your business in real time. Automated bank feeds, expense tracking, and customisable reports give you a clear picture of where your money is going, so you can focus on growing your business instead of chasing paperwork. Get one month free.

FAQs on business overheads

Here are answers to some frequently asked questions about business overheads.

What is the difference between overheads and operating expenses?

Overheads are a subset of operating expenses. While operating expenses cover everything you need to keep your business running, including direct costs, overheads refer only to indirect costs that support broader business operations. Think of overheads as the background costs of running your business, rather than the costs of making your products.

How can you reduce overheads without compromising quality?

Focus on efficiency and smarter spending rather than blanket cuts. Negotiate better rates with suppliers, use technology to automate repetitive tasks, and optimise energy usage to lower utility bills. The key is to identify which overheads are essential for quality and which are "nice-to-have" expenses that can be reduced or paused during quieter periods.

How do you calculate overhead cost per hour?

To calculate your overhead cost per hour, divide your total overhead costs for a given period by the total number of billable hours worked in that same period. For example, if your monthly overheads are €6,000 and your team works 400 billable hours, your overhead cost per hour is €15. This figure helps you set hourly rates that cover all your costs.

What is a good overhead ratio for a small business?

A healthy overhead ratio varies by industry, but many small businesses aim to keep overheads below 35% of their total turnover. The lower your overhead ratio, the more of each euro earned goes towards profit. Tracking this ratio over time helps you spot trends and take action before costs start eating into your margins.