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All businesses have costs associated with operating the business. Tracking those costs is an essential part of managing a business’s finance, and involves categorizing expenses. Indirect costs of the business, those costs not associated with creating or producing a product or service, are commonly referred to as a business’s overhead costs. As these costs are not revenue generating, if not managed they can take up a large portion of a businesses budget. Identifying these costs and tracking them early on when starting a business is necessary for success.
Types of Overhead Cost
Overhead costs typically come in three categories: fixed, semi-variable, and variable.
Tracking Overhead Cost
While there are the three main types of overhead cost, they will typically be broken down differently for the company’s income statement. Larger companies may choose to categorize overhead cost by breaking it down into department, with a general category for overall business expenses. Other companies may choose to categorize their overhead costs based on the activity being performed. Where one company may choose to break overhead costs into departments, thus including administrative employees’ salaries in their respective departments; another company may choose to create categories based on specific categories, choosing to include all employee salaries in one specific category. There is no specific correct way to handle the break down of overhead costs, as long as all costs are considered and it works for the person in charge of accounting.
The Importance of Overhead Cost
Tracking overhead cost is essential for operating a successful business because it helps identify the bottom line. For instance, a retail company may take their overall sales for the month and consider it successful, but in order to determine their level of profit they need to consider total sales for the month, then subtract any direct costs (not included in overhead) as well as all indirect costs (also known as a business’s overhead costs). Once salaries, rent, utilities, etc. have been subtracted from total sales, only then does a business have a clear view of their net profit, or bottom line.
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