What are overhead costs and how do they affect your business?

Published Tuesday 9 June 2026

Table of contents

• What are business overheads?
• Types of overhead costs
• Overhead cost examples
• Overhead cost formula
• How to calculate overhead costs
• Why knowing your overhead costs matters
• How to reduce overhead costs
• Manage your overheads with Xero
• FAQs on overhead costs

Key takeaways

• Overhead costs are the indirect expenses that keep your business running but aren't directly tied to producing your goods or services, such as rent, insurance, and admin salaries.
• Overheads fall into 3 categories: fixed costs that stay the same each month, variable costs that fluctuate with activity, and semi-variable costs that combine both elements.
• You can calculate your overhead rate by dividing your total indirect costs by an allocation measure like direct labour costs, giving you a clear picture of how overheads relate to production.
• Regularly reviewing and reducing overhead costs helps you set accurate prices, maintain healthy cash flow, and protect your profit margins.

What are business overheads?

Overhead costs are the indirect expenses your business incurs that aren't directly tied to producing your goods or services. They're the day-to-day running costs that keep your business operating, regardless of how much you produce or sell.

Common examples include rent, insurance, utilities, office supplies, and administrative salaries. These costs differ from direct costs, which are expenses you can trace straight to a specific product or service, such as raw materials or production labour.

The distinction between overheads and direct costs can sometimes be tricky, because how you classify a cost depends on your business type and structure. For example, rent for a factory floor might be a direct production cost, while rent for a head office is typically an overhead. The key test is whether a cost is directly linked to creating your product or service: if it isn't, it's an overhead.

Types of overhead costs

Understanding the different types of overhead costs helps you plan your budget and spot opportunities for savings. Overheads generally fall into 3 main categories based on how they behave as your business activity changes.

Fixed overheads are costs that stay the same each month, no matter how much your business produces. These include expenses like office rent, insurance premiums, and permanent staff salaries. You'll pay these whether you have a busy month or a quiet one.

Variable overheads rise and fall depending on your business activity. Marketing spend, shipping costs, and office supplies are common examples. During a peak trading period, these costs tend to climb.

Semi-variable overheads have a fixed base component plus a variable element that increases with usage. Your phone plan, for example, has a set monthly fee, but you'll pay more if you exceed your data or call allowance. Utilities often work the same way, with a base charge plus usage-based fees.

Beyond these 3 categories, it's also useful to think about overheads by function. Administrative overheads cover the costs of running your office and managing your business, such as accounting fees, office rent, and software subscriptions. Production overheads are indirect costs associated with your production environment, like factory utilities, equipment maintenance, and quality control. Separating these helps you see exactly where your money goes.

Overhead cost examples

Looking at specific overhead costs makes it easier to identify and categorise your own. Here are some of the most common overhead expenses South African small businesses face.

• Rent and property costs: Whether you lease an office in Sandton or a workshop in Durban, property costs are typically one of your largest fixed overheads. A small office might cost anywhere from R5,000 to R15,000 per month depending on the area.
• Administrative salaries: Wages for staff who don't directly produce your product, such as receptionists, office managers, and HR personnel, count as overhead. These are ongoing commitments regardless of how busy your business is.
• Insurance: Business insurance, public liability cover, and professional indemnity premiums are fixed overheads you'll pay year-round to protect your business.
• Utilities: Electricity, water, and internet are semi-variable costs. You'll always have a base amount to pay, but usage can push these higher. Load shedding-related costs, like diesel for generators, can add to this in South Africa.
• Marketing and advertising: Digital ad spend, social media campaigns, and print materials are typically variable overheads that fluctuate based on your marketing strategy and seasonal demand.
• Professional and legal fees: Accounting, bookkeeping, and legal advisory costs are administrative overheads. Many South African small businesses pay between R2,000 and R10,000 per month for external accounting services.
• Software subscriptions: Cloud-based tools for accounting, project management, communication, and customer relationship management are recurring overhead costs that often scale with your team size.

Overhead cost formula

Having a clear formula helps you measure how your overhead costs relate to your production output. There are 2 key calculations to know.

The overhead rate tells you how much overhead you're spending for every rand of direct cost:

Overhead rate = total indirect costs / allocation measure

The allocation measure is any direct cost figure tied to production, such as direct labour costs, machine hours, or material costs. This gives you a ratio that shows how heavily overheads weigh on your production.

The overhead percentage shows your overheads as a proportion of your total revenue:

Overhead percentage = (total overhead costs / total sales revenue) x 100

This percentage helps you understand how much of every rand you earn goes toward keeping the lights on rather than generating profit. A lower overhead percentage generally means more of your revenue is available for reinvestment and growth.

How to calculate overhead costs

Calculating your overhead costs doesn't have to be complicated. Follow these 5 steps to work out your overhead rate and understand what your indirect costs are really costing you.

Step 1: List all your business expenses

Start by gathering every expense your business has incurred over a specific period, such as a month or a quarter. Pull figures from your bank statements, invoices, and accounting software. Include everything from rent and salaries to office supplies and subscriptions.

Step 2: Separate direct costs from indirect costs

Go through your list and split each expense into 2 groups. Direct costs are tied to producing your product or service, such as raw materials, production labour, and manufacturing supplies. These direct costs are sometimes referred to as your cost of goods sold.

Indirect costs are everything else: rent, utilities, admin salaries, insurance, and other expenses that support your business but aren't linked to a specific product. Your indirect costs are your overheads.

Step 3: Categorise your overhead costs

Group your overheads into fixed, variable, and semi-variable categories. This makes it easier to see which costs you can control and which are locked in. You might also separate them by function, splitting administrative overheads from production overheads.

Step 4: Total your overhead costs for the period

Add up all your indirect costs to get your total overhead figure for the period. For example, if your monthly rent is R8,000, utilities are R1,200, and admin salaries plus other indirect costs come to R800, your total overheads for the month are R10,000.

Step 5: Calculate your overhead rate

Divide your total overhead costs by your chosen allocation measure. If you're comparing overheads to labour costs, and your direct labour costs for the same period are R2,500, here's how the calculation works:

Overhead rate = R10,000 / R2,500 = 4

This means that for every R1 you spend on direct labour, your business spends R4 on overhead costs. That's a 4:1 ratio. If that number feels high, it's a clear signal to review your indirect expenses and look for areas to trim.

Why knowing your overhead costs matters

Understanding your overhead costs gives you the financial clarity to make smarter business decisions. Without this knowledge, you're essentially guessing at your true costs, and that can lead to underpriced products, cash flow problems, and missed growth opportunities.

Accurate pricing: When you set prices for your products or services, you need to account for both direct and indirect costs. If you only factor in materials and labour, you'll undercharge and erode your margins. Knowing your overhead rate ensures your pricing covers the full cost of doing business.

Breakeven analysis: Your breakeven point is where revenue covers all your costs, including overheads. Understanding your total overhead figure tells you exactly how much you need to earn before you start turning a profit.

Cash flow management: High overhead costs eat into your cash reserves every month. By tracking overheads closely, you can anticipate tight periods, avoid shortfalls, and maintain positive cash flow. Including overhead expenses on your profit and loss statement is essential for understanding your true net income.

Smarter budgeting: When you know your overhead costs, you can build realistic budgets and forecasts. This is especially important for South African small businesses operating within tight margins, where an unexpected jump in costs can have an outsized impact. Learn more about budgeting and financial forecasting for your business. Understanding your cash flow management is equally important when planning around overhead expenses.

Cost-cutting opportunities: You can't reduce what you don't measure. Using tools like inventory management software alongside overhead tracking reveals patterns and highlights costs that have crept up. A quarterly review often uncovers subscriptions you no longer use, supplier contracts worth renegotiating, or processes you can automate.

How to reduce overhead costs

Reducing your overheads doesn't mean cutting corners. It's about spending smarter so more of your revenue flows to your bottom line. If you're just getting started, understanding your startup costs can help you budget for overheads from day one. Here are practical strategies that work for South African small businesses.

• Renegotiate supplier contracts: If you haven't reviewed your supplier agreements recently, there may be room to negotiate better rates. Get quotes from competing providers and use them as leverage. Even a small reduction on recurring costs adds up over 12 months.
• Consider flexible workspaces: You don't necessarily need a full-time office. Co-working spaces, shared offices, or hybrid remote arrangements can significantly reduce your rent and utility costs, especially if your team doesn't need to be on-site every day.
• Audit your subscriptions: Software subscriptions, memberships, and recurring services can quietly pile up. Review every subscription quarterly and cancel anything your team isn't actively using. Consolidating tools that overlap in functionality can also bring costs down.
• Automate where you can: Manual, repetitive tasks cost time and money. Accounting software automates bank reconciliation, invoicing, and expense tracking, freeing up hours you'd otherwise spend on admin. Expense tracking tools give you real-time visibility into where your money is going.
• Improve energy efficiency: With rising electricity costs in South Africa, energy-saving measures pay for themselves quickly. Switch to LED lighting, invest in energy-efficient equipment, and monitor your consumption to spot waste.
• Outsource non-core functions: Hiring full-time staff for every role isn't always the most cost-effective approach. Outsourcing tasks like bookkeeping, IT support, or graphic design to specialists can be cheaper than maintaining in-house capacity, and you only pay for what you need.
• Monitor expenses regularly: Make overhead reviews a monthly habit, not a yearly afterthought. Tracking your operating expenses consistently helps you catch cost creep early and make adjustments before small increases become big problems. Explore more cost-saving ideas for your business.

Manage your overheads with Xero

Staying on top of your overhead costs is one of the most effective ways to protect your profit margins and keep your small business financially healthy. With clear visibility into your indirect expenses, you can price confidently, budget accurately, and spot savings before they slip through the cracks.

Xero accounting software gives you real-time expense tracking, automated bank reconciliation, and smart reporting, so you always know exactly where your money is going. It's built to save you time on admin and help you make informed financial decisions. Get one month free.

FAQs on overhead costs

Here are answers to frequently asked questions about overhead costs.

What is the difference between overheads and operating expenses?

Overheads are a subset of your total operating expenses. Operating expenses include every cost of running your business, both direct and indirect. Overheads refer specifically to the indirect costs that aren't tied to producing a particular product or service, such as rent, insurance, and admin salaries.

Is salary an overhead cost?

It depends on the role. Salaries for staff who don't directly produce your goods or services, like office managers, receptionists, and HR personnel, are overhead costs. Wages for production workers or service delivery staff are typically classified as direct labour costs, not overheads.

What is a good overhead percentage for a small business?

There's no single ideal percentage, as it varies by industry. As a general guide, many small businesses aim for an overhead percentage below 35% of total revenue. Service-based businesses often have lower overheads than manufacturing or retail operations. The important thing is to track your percentage over time and work to keep it trending downward.

What is the difference between overhead and direct costs?

Direct costs can be traced to a specific product or service, such as raw materials, production labour, or packaging. Overhead costs are indirect: they support your business overall but can't be attributed to a single product. Rent, utilities, and administrative salaries are classic overhead examples, while cost of goods sold (COGS) represents your direct production costs.

What are examples of fixed and variable overhead costs?

Fixed overhead costs remain constant regardless of business activity, for example, office rent, insurance premiums, and permanent staff salaries. Variable overhead costs change with your level of production or sales, such as marketing spend, shipping costs, and office supplies. Some overheads, like utilities, are semi-variable: they have a fixed base plus a variable usage component.

How can you reduce overheads without compromising quality?

Focus on efficiency rather than blanket cuts. Renegotiate supplier contracts, audit your subscriptions for unused services, automate repetitive admin tasks with tools like accounting software, and consider flexible work arrangements to reduce property costs. The goal is to eliminate waste and spend smarter, not to strip out costs that support the quality of your product or service.