How to Calculate General Operating Expenses

General operating expenses are the costs that you have to spend to run your business regardless of whether the company has a lot of orders or is inactive. Good management of general operating costs will help businesses get a better output price for their products/services, and will show ways businesses can save costs and rearrange the model. business. However, these benefits only come from careful, diligent accounting staff. So read on to find out the best way to calculate overhead costs.

Table of Contents

Identify General Operating Expenses

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Understand that overhead costs are expenses that are not directly related to your product. General operating expenses are also known as indirect costs. Indirect costs such as rent, salaries for administrative staff, machine repair costs, and marketing costs, are important to business operations and must be paid on a regular basis.

In our example, indirect costs such as postage and insurance are essential to the business, but not the direct costs of creating the product.
When calculating overhead, always consider what counts as a fixed or variable cost. Fixed costs are numbers that don’t change, and variable costs are numbers that change with the company’s operations and production levels. ^{[1] X Research Source}

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Note that direct costs are the costs of creating a product or service. These costs will fluctuate based on customer demand for your product and the market price of the inputs. If you open a bakery, the direct costs will be wages and ingredients. If you open a clinic, the direct costs are doctor’s salary, stethoscope, etc.

The most common direct costs, as described above, are wages and materials.
Simply put, direct costs are paid for things that are on the production line while indirect costs are paid for the “main” production line.

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Create a list that lists each type of expense for each month, quarter, or year. You can choose the time periods you like, and usually companies break down costs on a monthly basis.

Stick to the time period you choose. If you charge monthly indirect costs, you will also have to calculate direct monthly costs.
Use programs like QuickBooks, Excel, or Freshbooks to help you manage your data more efficiently and easily.
Don’t worry about where the costs will be charged. You need to have an overall cost picture before calculating overall operating costs.

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Now find the overheads (indirect costs). Companies have to pay expenses such as taxes, rent, insurance, licensing fees, utilities, accounting and legal costs, administrative staff salaries, maintenance costs. equipment, etc. Look for all indirect costs.

Double-check past expense reports and invoices to make sure you haven’t overlooked any expenses.
Don’t forget about recurring expenses, like the cost of getting a new license or filing an application. While these costs are less likely to occur, they are still counted as general operating expenses.

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Use old expenses or estimate them if you don’t know your exact costs. If you are a new or aspiring entrepreneur, you should do a full research on supply costs, manpower, and other potential overheads.

If you have old accounting data, you can use it and apply it to next year’s expense plan. The plan numbers are usually the same year after year unless you make major changes to your business plan.
Average costs over 3 to 4 months to minimize the impact of unexpected expenses.

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Divide the expenses on the list into direct and indirect costs based on your business model. Different business lines will have different division and you need to decide this division yourself. For example, legal expenses are often shared between production costs, but they contribute directly to the business if you run a law firm.

If you’re still confused with division, think of overheads as expenses that you would still have to pay even if you stopped production immediately. So what costs will be overhead?
Update this list every time you come across a new expense.

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Add all the indirect costs together to get the total overhead. This is the cost you have to spend to maintain the business. In the example above, the initial overhead is $16,800. This is an important number when you are making a business plan.

Deeper understanding of General Operating Expenses

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Calculate the percentage of general operating expenses to total costs. That percentage shows how much your company spends to maintain and how much it spends to make a product. So let’s calculate the percentage:

Next, divide indirect costs by direct costs. In the example above, the indirect cost ratio is 0.35 (16,800 / 48,000 = 0.35).
Multiplying this number by 100 we get the overall operating cost percentage. Here we have a ratio of 35%
That means your company spends 35% of its total costs on legal costs, administrative staff, rent, etc. for each product the company produces.
The lower the overhead, the greater the profit. Therefore, a low overall operating cost ratio is a good thing.

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Next, compare your company’s overall operating expenses with those of other companies. The assumption here is that the companies that pay direct costs are relatively similar, and that the company with a lower overhead ratio will make more money selling products. By reducing overall operating costs, your company can sell products at a more competitive price and/and earn a higher profit. ^{[2] X Research Source}

Using General Operating Expenses to Improve Business Operations

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Divide overhead by labor costs to see how efficiently you’re using resources. Multiply by 100 to get the overall operating expense percentage per employee.

If this ratio is low, it means your company is managing costs effectively.
If the ratio is high, it is possible that your company employs too many employees.

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Calculate the percentage of revenue that must be spent on general operating expenses. Divide general operating expenses by revenue, then multiply by 100 to get the percentage. This is a simple way to see if you are selling enough goods/services to stay in business.

For example, if my company sells $100,000 in soap sales a month and I have to pay $10,000 to keep it afloat, I’m paying 10% of the revenue for general operating expenses.
The higher this ratio, the lower the profit margin

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Look for ways to cut or more tightly manage overhead costs if those ratios are high. This is one of the main reasons why you are not making much profit. You may be paying too much rent or may need to sell more products to cover your overall operating costs. Maybe, you have too many employees and don’t manage them properly to make them work effectively. Use these numbers to further analyze the business model and make changes.

All industries and companies have to pay general operating costs, but companies that strictly manage these costs will earn higher profits.
However, high overhead costs are not entirely negative. If you pay for good equipment or to satisfy your employees, you can get higher productivity and higher profits.

Advice

If you are calculating general operating expenses for the past, you can use the available numbers to calculate. If you want to estimate your overall operating expenses for the coming years, you need to use averages to calculate them. For example, to calculate future indirect costs you need data from many past accounting periods and calculate the average indirect cost of each item that may be incurred in the company in the near future. Likewise, to calculate future direct costs, you need to estimate average costs based on past and present data. For example, direct labor costs can be calculated by multiplying the average hourly wage by the average number of hours worked over a period. The results may not be accurate in practice, but this should be an approximate estimate.
Tracking overhead ratios on an ongoing basis – month-to-month, quarterly, and yearly helps minimize the impact of variables generated by cycles, purchasing sentiment, and raw material availability/cost .

Warning

The steps outlined above are intended to help you better analyze quantitative data. Every company is different, so optimizing overall operating costs is not an exact science.

Steps

Identify General Operating Expenses

Deeper understanding of General Operating Expenses

Using General Operating Expenses to Improve Business Operations

Advice

Warning

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