The ideal overhead percentage depends on the industry, size and type of business you run. Looking at overhead costs as a percent of sales, the best way to determine the ideal overhead percentage for your business is to take an average of your competitors. Your company's operational efficiency and profit-maximizing goals help determine where your optimal overhead is relative to the industry average. The challenge in calculating overhead percentage is finding the right data.
Common Overhead Items
In general, overhead is defined as anything that does not include direct labor, direct materials, or expenses billed directly to the customer. Common overhead items include rent, utilities and insurance expense, which can be found on the company's income statement. On the income statement, these costs represent the difference between gross profit and operating profit.
Overhead: An Indirect Cost
Even though overhead is considered an indirect cost that must be paid regardless of how high or low volume is, it can still be a variable, fixed or semi-variable cost. A variable cost changes with the level of business activity; fixed costs do not change, and semi-variable costs have a fixed cost up to a certain point. The level of business activity may not be defined by sales volume alone.
Overhead and Operating Margin
Business owners can look to two different types of margin for clues about how well a business is performing. The first is the gross margin; the second is operating margin. Gross margin includes all the costs directly associated with creating the product. Operating margin includes all the indirect costs associated with creating the product and operating the company. The costs of overhead are included in the operating margin, because they are indirect costs.
Calculating the Ideal Overhead Percentage for Your Business
Gather income statements for at least five different businesses in your industry. Calculate the overhead costs for each company. For example, if the gross profit is $100,000 and operating profit is $80,000, the overhead costs can be loosely estimated to be the difference between the two, or $20,000. Divide $20,000 by sales to get the percentage of overhead costs relative to sales. Average the five results to use as your first benchmark for an ideal overhead percentage. Optimize by choosing the lowest percentage target that allows employees to do their jobs well and achieve company growth while minimizing your overhead cost percentage.
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