Definition

Overhead costs or operating expenses are expenses that are required to run a business and cannot be linked to producing a product or service. Simply put, these are expenses that a business has to incur to remain in business, irrespective of its success level.Overhead costs cover all such costs that are seen on a company’s income statement excluding costs that are directly linked to manufacturing/sales of the product/service. For instance, the rentals that a company pays towards a facility are an overhead cost since these are not directly related to the product/service sold by the company.

Example

Although overhead costs are not directly connected to profit-making, they are crucial to a business since they offer critical support in the profit-making activities of the business. Overhead costs differ across companies depending on the business. Examples of overhead costs are:a. Rentb. Insurancec. Traveld. Advertising coste. Salaries f. Depreciation

Why it matters

Every business must closely monitor its overhead costs. Because these aren’t directly linked to revenues, they can significantly drain a business if not monitored or controlled. Let's say start-up rents office space in a business location to carry out operations that could also be done from home until it reaches a certain growth stage. This rental cost comes with staff and equipment costs too. The company must therefore reconsider the money spent on rentals and whether it can be invested in revenue-driving areas like marketing or advertising.

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