Financial Glossary
Overhead
Overhead encompasses all business costs that are not directly traceable to producing a specific unit of output or delivering a specific service. It includes fixed costs such as rent, insurance, and salaried administrative staff, as well as variable overhead like utilities that fluctuate with activity but cannot be assigned to a single product. In manufacturing and service industries, overhead is allocated to products or jobs using an overhead rate (Total Overhead / Allocation Base, such as direct labor hours or machine hours). Controlling overhead as a percentage of revenue is a core lever for margin improvement.
Problem & Application
A campground management company operates three parks and shares a central office staff -- a GM, a bookkeeper, and a marketing coordinator -- costing $180,000 annually. This overhead must be allocated across the three parks to understand the true profitability of each location. Using occupied site-nights as the allocation base (Park A: 10,000 nights, Park B: 6,000 nights, Park C: 4,000 nights), Park A absorbs $90,000 of overhead, Park B $54,000, and Park C $36,000. Before allocation, Park C appeared profitable; after, it barely breaks even. This insight prompts a review of whether Park C can increase occupancy or whether certain services can be centralized further to reduce its overhead burden.
In Short
Controlling overhead costs is crucial for maintaining profitability, as these expenses directly impact a company’s bottom line.