Overhead: Definition, Types, Examples, and How to Manage It

What is overhead?

Overhead refers to ongoing business expenses that are not directly tied to producing a specific good or service. These recurring costs keep a company operating but do not change in direct proportion to production volume. Examples include rent, utilities, insurance, and administrative wages.

Why overhead matters

Overhead plus direct costs determine profitability. Overhead is deducted from revenue on the income statement and influences pricing, breakeven calculations, and the amount of net income available for reinvestment or distribution. While some overheads indirectly support sales (for example, advertising or a convenient retail location), excessive overhead can force higher prices and hurt competitiveness; cutting too many overhead items can also damage quality or sales.

Primary categories of overhead

Overhead is commonly classified by how costs behave:

• Fixed overhead
• Costs that remain constant regardless of business activity (e.g., rent, some salaries, insurance, accounting fees).
• Variable overhead
• Costs that fluctuate with activity (e.g., sales commissions, shipping, certain maintenance tied to usage).
• Semi-variable (mixed) overhead
• Costs with a fixed baseline plus a variable component (e.g., utility bills that include a fixed service charge plus usage-based charges).

Functional categories
* Administrative overhead
* General day-to-day costs that support the business but aren’t part of production: office supplies, management and support staff salaries, legal and accounting fees, telecommunications.
* Can be further split into subcategories such as financial overhead (interest, taxes, audit fees) and selling overhead (marketing, sales salaries and commissions).
* Production (manufacturing) overhead
* Indirect costs incurred during production: factory rent and property taxes, supervisors’ salaries, equipment depreciation, repairs, and utilities tied to manufacturing.

Common examples

• Rent or facility costs — typically fixed and essential; reducing them may lower costs but can affect location, staff retention, or foot traffic.
• Utilities — water, gas, electricity, internet and phone; often semi-variable and reducible through supplier renegotiation or efficiency investments.
• Administrative expenses — office equipment, stationery, payroll for non-production staff; large area for savings but cuts can have indirect negative effects.
• Insurance, permits, licenses, depreciation, and professional fees.

Strategies to manage overhead

Aim to keep overhead as low as possible without harming operations or sales:

• Negotiate supplier and service contracts to secure better rates.
• Outsource or insource selectively — compare total costs and capabilities for services such as IT, payroll, accounting, and legal support.
• Streamline operations — eliminate redundant tasks and simplify processes to reduce waste.
• Adopt remote work or hybrid models to reduce office space and related costs.
• Leverage technology and automation for routine tasks while retaining human oversight for complex work.
• Regularly review and analyze overhead items to spot trends and assess the impact of potential cuts on quality and sales.

Conclusion

Overhead are necessary ongoing costs that do not directly produce goods or services but are essential to running a business. Effective overhead management helps set competitive prices, reach breakeven sooner, and maximize profits while maintaining service and product quality.