The cost of doing business: what is a business overhead expense?
No business will thrive for long without incurring certain types of expenses. These include overhead expenses, which refer to the costs of running your business. Your income statement will list your overhead expenses, which paints a picture of how efficiently your company is operating.
What exactly constitutes a business overhead expense? This guide will help you understand more about these business costs and how you can manage them more efficiently.
What is an overhead expense?
Overhead refers to the cost of operating your company, though it excludes the cost associated with creating your product or service.
A good way to think about overhead is that these costs tend to remain the same regardless of how well your business performs. These might include things like rent, insurance premiums, or other administrative costs. But like any type of business expense, your overhead can dramatically impact your bottom line.
Overhead expenses vs. operating expenses
Sometimes you'll hear the term "overhead" used to refer to all of the costs that go into running a business. But it's important to distinguish between business overhead expenses and regular operating expenses.
Operating expenses include those expenses made during normal business operations. These might relate to materials, equipment, or inventory. So for example, if you run an eCommerce business selling t-shirts online, the cost of your inventory and your packing materials would both be considered operating expenses.
A business overhead expense, on the other hand, would be any other business-related cost. Again, these tend to reflect ongoing costs — not directly related to materials or products — and are expenses that you'll pay no matter how your business performs.
Types of overhead expenses
Broadly speaking, overhead expenses can be broken down into three categories:
A fixed expense is one that doesn't change from month to month. A good example of a fixed expense might be a mortgage or rent payment for your commercial real estate, as well as certain employees' salaries.
A variable expense is one that can change dramatically from one period to another. These can refer to the cost of certain administrative expenses, such as office supplies, shipping costs, or other administrative overhead like fines or professional fees.
Some expenses can be classified as "semi-variable," which means that the expense is predictable but won't necessarily be the same each time. For instance, certain utility bills can be semi-variable, in the sense that you'll receive a bill each month but the amount will vary based on the amount of electricity or other services you've consumed in the last billing cycle.
Common examples of overhead expenses
What kinds of overhead costs can business owners expect to encounter? Here are some of the most common examples of overhead that your business will incur on a routine basis:
Rent or mortgage
Commercial real estate is a major business expense, and the payments you make on your rent or mortgage represent a fixed monthly cost. Unless your landlord raises your monthly rent or you opt to pay off your commercial mortgage early, these payments will remain static throughout the life of your business.
Utilities make up another significant business cost and will usually be paid on a monthly basis. Common utility payments include:
- Phone service
But while these bills are recurring, they aren't necessarily fixed. This variability means that you can potentially find ways to save money by conserving electricity, water, or gas during your billing cycle, which could improve your bottom line.
These days, your utilities aren't the only monthly bills you'll have to worry about. You may have other administrative fees such as:
- Virtual meeting platforms (e.g., Zoom)
- Online accounting services
- Invoicing and/or payment software
- Monthly subscriptions to trade publications
Like your utility payments, these bills will usually be paid monthly, though they will not typically vary from one pay period to the next.
Many small businesses rely on loans to either start or improve their core activities. If you've taken out a small business loan to fund your company at any point in the past, you'll likely have to make regular payments to repay this loan. These payments will include the cost of the loan itself, as well as any interest.
Depending on the nature of your industry, you'll likely have to carry multiple types of small business insurance. These might include:
- Property insurance
- Liability insurance
- Health insurance
- Car insurance for commercial vehicles
Since none of these expenses relate directly to generating revenue, they are classified as overhead. Fortunately, they generally represent a fixed expense, though if you have to use any of these policies, it's not uncommon for insurance providers to raise your monthly premium.
Employees' salaries and benefits
Payroll will naturally represent a major expense, and in most cases, you'll have to cover salary payments regardless of how well your business performs.
Additionally, full-time staff members will be entitled to certain benefits, including health insurance, retirement plans, life insurance, and other incentives to help you attract and retain top talent.
On top of a salary, you might also offer your team other benefits, such as:
- Stocking the breakroom with free coffee/snacks
- Providing discounts on gym memberships
- Hosting retreats
- Distributing financial incentives for positive performance
All of these items can add up quickly, making payroll one of your greatest challenges in terms of managing external expenses.
Every small business owner understands the need to stay on top of business taxes. These include:
- Income taxes
- Payroll taxes (disability, workers compensation, etc.)
- Self-employment taxes
Granted, the amount of tax you pay will vary widely from year to year, based on the amount of profit you manage to generate during the course of the tax year. But taxes will always be a regular burden for today's entrepreneurs, many of whom will make estimated quarterly payments to avoid penalties and to remain in compliance.
Finally, most businesses will discover that they have a host of additional fees that are related to keeping the company going.
These fees can range from stocking the toilet paper in the employee restroom to hiring a legal team to assist with taxes or regulatory compliance. Basically, all fees that are not directly related to generating profit will be classified as business overhead expenses.
Business overhead expense insurance
In order to succeed in business, you'll have to manage these expenses and leverage them against your company's profits. But what happens if you, the owner, get hurt or experience some form of disability?
If this happens, you'll need insurance coverage to ensure that your administrative needs are taken care of. This coverage is what's known as business overhead expense insurance.
What is business overhead expense (BOE) insurance?
Business overhead expense insurance (or simply "Business overhead insurance") is a type of disability coverage that provides for your overheads should you become injured or disabled. If this should happen, the insurance provider will pay a monthly benefit based on the estimated amount that you would ordinarily pay in overhead fees.
What does business overhead expense insurance cover?
Business overhead insurance provides for a small variety of covered expenses, such as:
- Interest payments on outstanding loans
- Utility payments
- Office supplies (postage, stationery, etc.)
- Maintenance of office equipment
- Monthly average taxes
- Employee benefits
- Malpractice insurance
- Professional memberships/subscriptions
Basically, this type of insurance policy will help you cover all of your overhead, though the exact nature of the coverage will depend largely on your provider.
Some providers offer optional "riders" that can be used to modify or extend your insurance coverage. These might be particularly important if you purchase a group policy, where you may have a diverse cross-section of needs should any of your workers experience a disability.
However, these additional riders typically raise your premiums and can vary between providers.
All of your plan information will be located on your insurance certificate. If you want additional information on what these plans might cover, contact your current insurance provider to discuss options.
Tips to lower your business expenses
Anyone in business understands that raising your profit margin involves lowering your expenses, including your overheads. Here are some tips to help you decrease these costs and streamline your operations:
Switching to LED lighting and energy-saving power strips can help you save on your monthly utility payments. As an added benefit, your clients may appreciate working with an organization committed to environmental sustainability, so going green will be good for profits all around.
Outsource and automate
The money you spend on employees will significantly impact your bottom line. This cost is why many modern entrepreneurs are opting for modern solutions to keep their staffing needs to a minimum.
You might consider outsourcing your accounting needs to an outside firm, saving you money and increasing your accuracy. Similarly, relying on the latest invoicing or payment software can help you work faster through automated features, which can reduce the total number of labor hours you devote to these sorts of administrative tasks.
Everyone dreams of the corner office. But success takes time. When you're first starting out, try to go for a minimalist approach when it comes to your office or warehouse.
Smaller space means smaller monthly payments, which will reduce your overhead. If you operate a storefront, you can find creative ways to "jazz" it up, but your backroom can wait until your cash flow significantly improves.
Review your contacts
If you've been in business for a while, you understand how your actual expenses are often dictated by your vendors and suppliers. Maybe it's time to rethink these agreements.
Contact your current vendors and see if they'd be willing to negotiate a new contract, one with a better price for you and your company. If not, maybe it's time to shop around for new suppliers, comparing prices using the information provided on the company websites.
Automate and save
One of the best ways to save money is by using the right tools. Invoice2go offers an innovative platform that allows users to create and send invoices right from their phone or mobile device.
You can also send automatic payment reminders and track your business expenses through our advanced reporting features. Sign up now, and you'll receive a no-obligation free trial, allowing you to see how these features can revolutionize your business and save you money.
Frequently asked questions
Here are some answers to common questions about overhead expenses and how to manage them:
Your premiums can vary by provider, as well as the size of your monthly benefits and the benefit period you choose.
Generally, your premiums will be on par with your other insurance payments. For specific questions, you might ask your plan administrator to speak with the underwriting department of your provider to discuss options, riders, and the length of your benefit period.
As a general rule, the IRS allows business owners to deduct expenses incurred during the normal operation of their business. This rule means that your overhead can be deducted from your taxes, which can reduce your payments and increase your profitability.
Additionally, any premium payments you make for BOE insurance are also tax-deductible, just like all of your insurance payments. This deductibility can reduce the burden on you and your group if you opt for this type of coverage.
You'll report this data on your income statement, and you'll frequently be asked to provide this information when applying for a small business loan.
Your overhead itself can be calculated simply by adding all expenses together. But it's also helpful to calculate your business overhead percentage, which you can determine as follows:
(Overhead) / (Monthly income) x 100% = Business overhead percentage
Generally speaking, the lower the percentage, the better. A low percentage usually indicates that your business is profitable, just as long as you're not sacrificing quality. When the percentage is high, it's a sign that you need to find ways to cut spending to improve your profitability.