What are overheads?
Overheads are the ongoing costs of running a business, such as rent, insurance and software, that are not linked to any particular product or job.
What overheads means
Overheads are the costs you pay to keep the business open, whether or not you make a sale this week. They are different from direct costs, which rise and fall with each product sold or job completed. A plumber's copper pipe is a direct cost; their van insurance, accountant and phone contract are overheads.
Most overheads are fixed costs, but some are semi-variable, such as electricity in a workshop or a card terminal with a monthly fee plus a charge per transaction.
Common examples
- Rent, business rates and service charges
- Insurance and professional subscriptions
- Accounting software and IT
- Salaries of staff who are not directly billable, such as admin
- Marketing and website costs
- Utilities, phone and broadband
- Accountancy and legal fees
Example
A small marketing agency earns £360,000 a year. Its monthly overheads are:
| Cost | Monthly |
|---|---|
| Office rent and service charge | £3,500 |
| Admin salary and employer costs | £2,800 |
| Software subscriptions | £600 |
| Insurance, accountant, phone | £600 |
| Total | £7,500 |
That is £90,000 a year, or 25% of revenue. If the agency bills 4,000 hours a year, each hour carries £22.50 of overhead before any designer's salary is counted. Pricing below that, plus direct costs, loses money however busy the team is.
Why it matters for your business
Overheads set your break-even point: the sales you need each month just to stand still. Knowing the figure helps you price properly, judge whether a new hire or bigger office is affordable, and spot costs that have crept up. Reviewing subscriptions and contracts once a year often finds savings that go straight to net profit.
Most business overheads are allowable expenses for tax, so they reduce your Corporation Tax or income tax bill, provided they are incurred wholly and exclusively for the business.
Overheads vs direct costs
Direct costs (also called cost of goods sold) sit above the gross profit line. Overheads sit below it and reduce gross profit to operating profit. Keeping the two apart in your accounts shows whether a weak month came from poor margins or from high running costs.
Reviewing overheads
Once a year, list every recurring cost and ask whether it is still needed, still the right size and still the best price. Software subscriptions for people who have left, insurance policies that overlap and contracts that rolled over at a higher rate are common finds.
Common questions
It depends on the sector. Many service businesses run with overheads of 20% to 35% of revenue, while retailers and restaurants are often lower because their direct costs are higher. Track the figure over time: a rising percentage is a warning sign even if total sales are growing.
Most are. Costs incurred wholly and exclusively for the business, such as rent, insurance, software and accountancy fees, reduce taxable profit. Business entertaining and personal costs are not allowable, and capital items like equipment are relieved through capital allowances instead.