Overheads - vs - Cost Of Sales

Overheads aren’t related to direct material costs or production. Instead, they are the type of general costs that are involved in keeping most businesses running like paying for bookkeeping services or running your business premises. They are generally ongoing costs whether you have actually sold anything and they will probably be the same every month. 

 

For example, if you are an artist or craftsperson with a rented workshop you will have to pay for the space every month even if you don’t have any commissions and don’t create anything. 

 

However, some costs, such as your utility bills, might vary if you need to run heating in the winter or air conditioning in the summer. They might also go up if you increase production, in which case they might be a cost of sales. 

 

Your overheads could also include marketing, promotions and other expenses involved in selling your products or services. These would continue even if you didn’t sell anything for a short time. Overheads could fall in to categories such as: 

 

 

You might also include step costs which are constant for a certain level of activity but increase or decrease significantly when thresholds are passed. These create a saw tooth or step shape to your expenses graphs. Understanding step costs can help you assess what impact increases and decreases in production can have on your business. 

 

Your overheads affect your net profit, so if sales reduce or costs increase reducing your overheads is one of the clearest ways to reduce expenses. You might review contracts and terms and conditions with your suppliers, cut back on lighting or heating when your premises are empty, or outsource some administrative functions when employees leave rather than taking on full-time replacements. 

 

Business expenses such as materials and machinery can’t be avoided when making your products or delivering your services. Only businesses with a product or service to sell can list cost of sales on their income statement. When these costs are subtracted from revenue, they helps determine your company's gross profit. 

 

If you can deliver the same amount for less through improved efficiency, you will increase your profitability. However, cutting costs by, for example, reducing the number of people you employ could reduce production and income and you will still need to pay your overheads. 

 

What’s included will vary by industry so fuel for vehicles could be an overhead but if you run a taxi service it would be a cost of sale. 

 

If your products need raw materials and their prices are increasing dramatically you will have to look at your options. This might include finding alternative materials or ways to reduce the amount you need through research and development; you might pass the costs on to customers or stop making the product. 

 

Having a clear idea about your business overheads and what contributes to the cost of your sales will give you a better picture of how your business as a whole is affected by inflation. Your cost of sales are essential for you to do business but you could reduce them by improving efficiency. Your overheads keep your business running smoothly but should be reviewed regularly to help increase your profitability. 

 

Keeping your financial accounts up to date, regularly reviewing your costs, and having realistic projections will help you manage the impact of inflation for your business in the short and medium term. 

 

If you would like to know more about how accurate financial records and reports can help your business please get in touch.