Figuring out your small business’s overhead rate and percentage includes dividing the organization’s 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. The whole purpose of determining the overhead rate and percentage of expenses is to decide the right and reasonable cost of products. There are a few steps to follow to calculate the overhead rate and ratio for small businesses. 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 determining the overhead rate in any company, whether it is a small or more significant business. To calculate the direct payments, 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 materials and labor directly paid to the workforce, as well as everything else involved in manufacturing the mobile phones, will be included in the direct expenses. Direct expenses are directly proportional to the number of products manufactured each year.

However, indirect expenses align with manufacturing costs, such as the sales and customer services department, taxes, marketing, administrative expenses, insurance, etc.

## 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 by that of all indirect costs. The answer is the overhead rate.

## Step Three – Calculate the Overhead Percentage

Once you have calculated the overhead rate of a small business, you shall multiply the overhead rate by a hundred to determine the overhead percentage.

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 costs for each month as the company is in its early stages. The frequent calculation and evaluation led the company to revise and analyze costs and fees.

### Why is it essential to determine the overhead rate and expense?

Determining the overhead rate and percentage is important 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 product prices. Companies are advised to review their overhead costs bi-monthly, monthly, and quarterly by doing regular bookkeeping.