Figuring out your small business’s overhead rate and percentage includes dividing the organizations’ indirect and direct expenses. As soon as the company figures out the overhead costs, it makes it easier for the company to decide the prices for the products and services. These pricing decisions are necessary as this will lead the company to reduce or raise prices accordingly.
Appropriately pricing products and services will help the business stay competitive in the market. The whole purpose of determining the overhead rate and percentage of expenses is to decide the right and reasonable cost of products. To calculate the overhead rate and ratio for small businesses, there are few steps to follow. Here are the steps to follow to calculate the overhead rate for a small business accurately.
Step One – Calculate the sum of the company’s direct and indirect expenses
Calculating the sum of the company’s direct and indirect expenses is the primary step to determine the overhead rate in any company, whether it is a small or larger business. To calculate the direct expenses, align the cost of direct labor and direct material required to manufacture the company’s products or services.
For example, suppose the company sells mobile phones. In that case, the cost of material and the labor cost directly paid to the workforce, and everything else involved in the manufacture of the mobile phones will be included in the direct expenses. Direct expenses are directly proportional to the number of products manufactured each year.
Step Two – Calculate the overhead rate
Once you have calculated the direct and indirect expenses of the company, the next step is to divide the sum of all direct expenses with that of all indirect expenses. The answer is the overhead rate.
Step Three – Calculate the overhead percentage
Once you have calculated the overhead rate of a small business, next, you shall multiply the overhead rate by a hundred to determine the overhead percentage.
How often shall overhead rate and overhead expense are ideally calculated for small businesses?
Usually, the overhead rate and percentage in many countries are calculated yearly. However, in a small business, the overhead rate and ratio are calculated each month to evaluate the expenses and cost for each month as the company is in its early stage. The frequent calculation and evaluation led the company to revise and analyze the cost and expenses.
Why is it essential to determine the overhead rate and expense?
Determine the overhead rate and percentage is an important thing for all kinds of businesses. This calculation allows the management of any business to make sensible operation decisions. The rate allows the company to keep track of the profit margin by contrasting the expenses with the cost. Also, the rate lets the company predict its profitability for the upcoming months and years.
The company shall ideally have an overhead expense and cost that shall significantly include a slight profit margin. Once a company calculates the overhead rate and percentage, it comprehends the effect of overhead on various costs involved in a business. It helps the company decide what role the rate plays in the prices of the product. It is advised for the companies to review their overhead costs bi-monthly, monthly, and quarterly by doing regular bookkeeping.
If you commit to cutting your business operating expenses, you will need to calculate your overhead rate and assess your current situation to develop a financial strategy. This strategy could include staff changes or cutting spending. Keeping costs down for your small business should be a year-round effort. Therefore you will need to recalculate your overhead rate regularly to make the best financial decisions for your business.About Complete Controller® – America’s Bookkeeping Experts Complete Controller is the Nation’s Leader in virtual bookkeeping, providing service to businesses and households alike. Utilizing Complete Controller’s technology, clients gain access to a cloud platform where their QuickBooks™️ file, critical financial documents, and back-office tools are hosted in an efficient SSO environment. Complete Controller’s team of certified US-based accounting professionals provide bookkeeping, record storage, performance reporting, and controller services including training, cash-flow management, budgeting and forecasting, process and controls advisement, and bill-pay. With flat-rate service plans, Complete Controller is the most cost-effective expert accounting solution for business, family-office, trusts, and households of any size or complexity.