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Overhead costs in bookkeeping are all those expenses that are used to manage a business. These expenses are those deducted from the proceeds that constitute the gross operating profit margin of the commercial activity. To have the net margin, you must deduct the income tax payable to the state. Overhead involves general expenses that are common in both the manufacturing and service sectors. These expenses can include rent, salaries or wages, utilities, insurance, taxes, and other expenses to run the business. Some examples of the industries in which overhead costs play a fundamental role include:

 

Overhead Costs in Retail Industry

In the retail industry, there are different types of costs for doing business. A common practice is that the goods or products have to be manufactured before selling in the market. The cost associated with the process refers to the direct overhead costs of production. Besides, the cost incurred in the term to pay the retail workers who directly participate in sales, such as sellers and cashiers, refers to the direct labor overhead costs. Also, the additional costs of the business are classified as indirect costs. For example, labor costs for executives who do not have direct sales (i.e., accountants, staff, and managers) are an example of indirect costs or overhead costs. Rental in commercial premises is another form of administrative or property expense in the retail industry. Other types of costs include the cost of public services, such as electricity, water, telephones and Internet services, consumables (i.e., bags for customers and receipts for paper prints), and so on. Check out America's Best Bookkeepers

 

Overhead Cost in Construction Industry

Overhead costs are defined as the ongoing expenses that are necessary for running a business. Overhead costs are different in the construction industry compared to the company operating in any other sector. The work nature in the construction industry requires an association with independent contractors, regular change of location, rent of equipment, and labor expenses, which distinguish it from any other industry. The overhead costs in the construction industry can be categorized as direct overhead costs and indirect overhead costs. The example of such direct overhead costs in the construction industry includes the salaries, employees’ compensation, and payment to staff (e.g., bookkeepers, managers, and administrators) who do not work on the actual work site. Furthermore, overhead costs in the construction industry further include the business’s physical office, rent, public services, telephone lines, Internet services, insurance, marketing, advertising, travel and legal expenses, and so on. Besides, overhead costs at the worksite include the expenses associated with trailers, project fees, hand drills, cranes, excavators, sanitary installation, drinking water expenses, supervisors at work, and so on.

 

Overhead Costs in Apparel Industry Check out America's Best Bookkeepers

Overhead costs in the apparel or garment industry include the costs that are not directly related to production. Regardless of the number of garment factories that produce income from the plant, they must meet the monthly fixed costs. Depending on the organizational structure, the example of overhead costs may vary from factory to factory. When calculating the overhead costs of a production plant, only the overall costs of the plant are considered. In contrast, if you calculate the overhead costs of a construction business that has marketing, design, sales, and warehouse departments, then there will have many other parameters of determining overhead costs. Common overhead costs in a garment or apparel industry may include building rent, salaries, electricity bills, phone bills, internet bills, transport expenses, expenses on consumables i.e., diesel or chemicals for finishing department, pantry expenses, administration cost, housekeeping, employees’ welfare expenses, printing, overtime expenses, stationery, and so on.

 

Overhead Costs in Furniture/Fixture Industry

In the furniture industry, production of an item requires materials to be purchased, salaries/wages to be paid to workers, and other expenses that are directly and indirectly associated with the production process. The common example of overhead costs in furniture/fixture industry includes indirect material (i.e., oil lubricants, stationery, consumable stores, printing, glue, cotton waste, nails, and polish); indirect labor (i.e., salesmen’s salaries, wages of storekeepers and security guards, directors’ fees, etc.); and other indirect expenses (i.e., rent, depreciation, lighting, insurance charges, etc.). Check out America's Best Bookkeepers

 

Overhead Costs in the Hotel and Tourism Industry

The term indirect costs, which can be fixed or variable in the hotel industry, is used to distinguish expenses directly related to hotel accommodation and non-commercial and commercial costs. The common example or role of overhead costs in hotel and tourism industry include wages to employees, employees health premium, maintenance fees, advertising cost, reservation expenses, guest room amenities, laundry operations, transportation, administration & general expenses and so on.

Check out America's Best Bookkeepers 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-hosted desktop where their entire team and tax accountant may access the QuickBooks™️ file, critical financial documents, and back-office tools in an efficient and secure 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. Check out America's Best Bookkeepers

In bookkeeping, a business needs to record the direct cost, and at the same time, it is also essential to have a record of indirect cost. Overhead costs are additional costs not directly attributable to the primary production, not included in the salaries of key personnel and the cost of raw materials. For a business, such costs are as essential to include in bookkeeping as direct costs, since it allows the entire company to operate.

Unlike direct costs, overhead costs consist of the expenses of raw materials, components and materials, salaries of the staff and insurance premiums, training cost, travel expenses, depreciation expense, and so on. However, it is fundamental for a business to lower the overhead costs to keep the overall cost lower. Therefore, the following are the ways through which a company can reduce its overhead costs to ensure the efficient practice of bookkeeping:

 

  1. Management of stocks or inventory

For business, it is essential to manage its inventory properly. It is not advisable for production to be stored for a long time. This means that the company has the capital that has been immobilized in production. This also generates storage costs. The higher the turnover rate of stocks or inventory, the greater the surplus obtained by the activity. We must not forget the defective stocks; they represent an irrecoverable cost for the company, so we must reduce to a minimum the rate of faulty products.

 

  1. Management of collections and payments

Usually, businesses are afraid to sell numerous products/services immediately without considering the situation in which they sell their products/services. It leads to severe liquidity concerns since the suppliers had to be paid when the customers had not yet been charged. The ideal situation would be to collect the products sold as soon as possible and delay payment to the maximum, with the temporary difference that is believed to “put money to work” and get some profit.

 

  1. Optimization of the logistic cycle

 It is understood as such, the time and processes that take place since the company receives the raw materials until the customer buys the final product. It is necessary to eliminate downtime, as it causes efficiency losses, delays in the delivery of the product. Besides, if the breakage of a machine produces the products/services, they entail repair or replacement costs for the device. Personnel errors can also cause additional costs. The problem is that they are difficult to control, but they can be minimized by encouraging and raising awareness among workers.

 

  1. Take advantage of social networks

With the use of social networks, in addition to customer loyalty, you can supply a series of activities that would involve a cost for the business. Depending on the service you want to offer, you can use a social network. For example, a company can enable customer service through Twitter, Facebook, or consultation forums. With these means, you can save time and cost when solving incidents. Similarly, through any social network, you can create small opinion surveys to know the opinion of consumers about the products offered.

 

  1. Lower financial expenses

Conceivably, this aspect is the most complicated to attain for a business as it requires bargaining power with the banks and those that do get it to do so under conditions that, in many cases are unacceptable and end up causing the “death” of the company. The help of a professional adviser can be vital to fighting the rates that have established the banks, and that, in principle, is negotiable.

 

  1. Save on Telecommunication

This is another area of ​​activity that involves more expenses within the structure of a company i.e., misuse of technologies such as fixed and mobile telephony, hardware, software, wireless networks, printing and digitalization of documents, and so on significantly increases expenses. Therefore, by controlling specific costs, the overall overhead cost can be reduced.

 

  1. Focus on profitable products/services

One of the ways to start reducing overhead costs is to review the profitability of the products/services offered. Here, a company should determine which products/services provide maximum benefits. Then, focus on giving efforts on the most profitable products/services and cut those that do not offer a return to your business.

 

  1. Spending tracking

If you do not know where your business earnings are going, then you should know where you can cut down or stop spending. Be sure to keep track of all business costs. Regardless of using papers for bookkeeping, you can use a laptop to write all the expenses or use accounting software, and review each area where the overhead cost can be reduced.

Check out America's Best Bookkeepers About Complete Controller® – America’s Bookkeeping Experts Complete Controller is the Nation’s Leader in virtual bookkeeping, providing services to businesses and households alike. Utilizing Complete Controller’s technology, clients gain access to a cloud-hosted desktop where their entire team and tax accountant may access the QuickBooks file, critical financial documents and back office tools in an efficient and secure environment. Complete Controller’s team of US based accounting professionals are certified QuickBooks™️ ProAdvisor’s providing bookkeeping, record storage, performance reporting and controller services including training, cash-flow management, budgeting and forecasting, process and controls advisement, and bill-pay services. 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.

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What is Utilization Ratio?

The utilization rate is an important ratio that companies can use to charge their clients. The ratios are used for maximizing the productivity time for employees. It can reflect the effectiveness of billing and the overall productivity of the company. There are two different types of methods used in bookkeeping for calculating indirect and direct labor expenses utilization ratios.

Method One

The first method is used for calculating the total billable hours divided by the number of hours recorded in a particular time period. For example, if the total hours are 60 but the hours billable are 30, then the utilization rate would be 30/60 = 50%. Using this utilization ratio, if the company is willing to cease recording their non-billable time, the ratio will always be equal to 100%.

Method Two

The second method used for calculating labor utilization rate uses the total hours billable divided by a fixed number of hours for each week. An example will help elaborate this formula. If there are 22 billable hours recorded in a predetermined 40 hours per week, then the utilization ratio will be calculated as 22/40 = 55%.

Why are Labor Utilization Ratios Important?

Company leaders rely on utilization ratios to significantly identify how much of the company’s workforce is currently employed and productive. It provides how the current workforce is performing and the required performance from current employees. If the ratio indicates an overproduction, then the company must hire more people to improve and balance productivity based on utilization rates.

Direct Labor Utilization

A company’s payroll is considered the largest organizational expense. Companies want to make sure that their payroll costs are generating sufficient income. Direct labor utilization ratio indicates how much a company is spending each year for direct labor.

The remainder payroll associated costs are considered as indirect labor costs. Examples of indirect labor costs are:

  • Amount spent on training employees
  • Administrative expenses
  • Marketing expenses
  • Paid vacations
  • Taxes

How to Calculate Direct Labor Utilization Ratio

The calculation needed for direct labor utilization ratio includes: dividing the total payroll amount associated with direct labor by the total cost of payroll for that specific period which will give the direct utilization ratio. For example, if your company is spending $4000 on the payroll for a specific pay period and pays an additional $3000 in direct labor expenses, then the utilization ratio for direct labor is 75%. (3000/4000 = 75%)

On average, the direct labor utilization ratio must be around 65%. A value higher than 65% will indicate that the company is utilizing its labor force efficiently. Companies that have less paid vacations and paid training will have a lower utilization cost.

Indirect Labor Utilization

Overhead costs are also called indirect labor costs. Labor overhead costs are directly associated with the different materials used for direct labor. Calculating indirect labor utilization is different and here’s what we need:

  • The number of hours an employee has worked: if the employee worked for 52 weeks per year * 40 hours per week, then he/she worked for almost 2,080 hours.
  • Deduct the total time spent on holidays per year: 45 days or 360 hours (including sick leaves, public holidays, training and seminars) 360 – 2,080 =1720 hours

Hence, the 1720 hours is our total hours spent by one employee as indirect labor utilization.

Check out America's Best Bookkeepers
About Complete Controller® – America’s Bookkeeping Experts Complete Controller is the Nation’s Leader in virtual accounting, providing services to businesses and households alike. Utilizing Complete Controller’s technology, clients gain access to a cloud-hosted desktop where their entire team and tax accountant may access the QuickBooks file and critical financial documents in an efficient and secure environment. Complete Controller’s team of  US based accounting professionals are certified QuickBooksTMProAdvisor’s providing bookkeeping and controller services including training, full or partial-service bookkeeping, cash-flow management, budgeting and forecasting, vendor and receivables management, process and controls advisement, and customized reporting. Offering flat rate pricing, Complete Controller is the most cost effective expert accounting solution for business, family office, trusts, and households of any size or complexity.

Businessman hand calculate bout cost with laptop for search data.
Expecting to achieve the right strategic balance in inventory in the beginning of a new business is not an easy task. Manufacturing businesses aim to minimize their work in process in order to maximize their profitability. Simultaneously, they also look for alternative routes to minimize their production and post-production costs as much as possible to increase their yearly profits. For small businesses, such as a bakery, it is hard to find the right WIP costs since you cannot anticipate exact labor and overheads costs where ingredients are easily transformed from raw material to a finished product. For big setups, you can easily calculate WIP through accounting/bookkeeping knowledge and wisdom.

Is There A Difference Between Work In Process And Work In Progress?

Work in Process

These terms are often used interchangeably because WIP is perceived as the same thing. However, there is a slight difference between these two terms that mostly lies in the context. Work in process refers to the production costs of partially-completed goods, which means the manufacturer’s inventory that is not yet completed. It includes different costs like raw material, labor, and overheads which need to be known for determining per unit cost of goods manufactured.

This indicates that work in process speaks more of the inventory side of things, whereas work in progress involves the construction of long-term costs as well. For lowering work in process costs, manufacturers need to play smart and make their raw material purchases from the most affordable vendors in their vicinity. Also, they need to hire labor for the production shifts at competitive rates and minimize overheads costs as much as possible. The final per unit price can only be determined if manufacturers know the exact level of output from the resources applied. In short, whatever is consumed on the factory floor for the production of goods such as the direct cost of raw material, direct costs of labor and factory overheads for the production period. This will give an exact per unit cost. The formula for calculating Work in Process is:

Work in Process = (operating inventory goods in process + raw material used + direct labor during the period + factory overhead for period) – ending inventory

Work In Progress

Work in progress involves the construction of long-term assets that will be used for the production of goods that are not yet completed. Until the time construction work is completed and the facility starts to manufacture goods itself, the amount spent on partially completed construction of long-term assets would fall under work in progress. In the balance sheet, the amount spent will be treated in long-term assets under the plant and equipment section. When construction wraps up, it will no longer be treated as work in progress. Depreciation of long-term assets starts as soon as the whole building and infrastructure is operational and starts to produce goods.

Cost Saving Benefits

The key cost-saving benefits of work in process and work in progress are efficiency, accuracy, traceability, and productivity. Obviously, every production house strives to minimize the work in the process due to lack of production or manufacturing knowledge and awareness. Businesses can’t survive for long if the per unit price of goods is only based on vague assumptions and mere guesses. Knowing the actual price of the manufactured product is absolutely essential for setting the correct price of the product with markup. For example, if you can determine the exact per unit price of the product to be $5 and if you expect to sell the product directly to the retailers for $7, which means a markup of $2, you will know exactly how much profit you are earning by selling each unit.

Work In Progress—Done Right!

You may be proficient at manufacturing goods in your production facility but not at costing. For ideal costing, you need to hire an in-house accounting expert for determining and revealing the exact per unit cost of production. Based on manufacturing and bookkeeping records, the expert will help you put the right production order in place for optimal results.


Check out America's Best Bookkeepers
About Complete Controller® – America’s Bookkeeping Experts Complete Controller is the Nation’s Leader in virtual accounting, providing services to businesses and households alike. Utilizing Complete Controller’s technology, clients gain access to a cloud-hosted desktop where their entire team and tax accountant may access the QuickBooks file and critical financial documents in an efficient and secure environment. Complete Controller’s team of  US based accounting professionals are certified QuickBooksTMProAdvisor’s providing bookkeeping and controller services including training, full or partial-service bookkeeping, cash-flow management, budgeting and forecasting, vendor and receivables management, process and controls advisement, and customized reporting. Offering flat rate pricing, Complete Controller is the most cost effective expert accounting solution for business, family office, trusts, and households of any size or complexity.