What are overhead costs? Types, examples, and how to cut them

Overhead costs are the ongoing, indirect expenses of running your business that aren't tied to producing a specific product or delivering a specific service. That spend is usually spread across things like company cards, software subscriptions, and vendor bills.

Once you can classify overhead and spot it in each spending category, you can control it before it eats your margin.

What are overhead costs?

Overhead is what you pay to keep the business open, whether or not you sell anything this month. If you'd pay it in a month with zero sales, it's overhead. If you pay it because a specific product or client job exists, it's a direct cost.

You have to cover overhead before you earn any profit, so it sets the floor for your pricing. It also creeps up as you grow. Every new hire adds software seats and often a new company card, and few of those purchases get a second look.

You may see overhead called indirect costs or overhead expenses, and both mean the same thing. People also use operating expenses (OpEx) as a synonym, though the two terms don't cover exactly the same costs. Most scaling companies carry the same core overhead expenses:

• Office rent or coworking memberships
• Software subscriptions
• Business insurance
• Utilities and internet
• Accounting and legal fees
• Administrative salaries

If a cost on your books looks like one of these, treat it as overhead until you can trace it to a specific job.

Overhead costs vs. direct costs

Direct costs are expenses you can trace to a specific product or job, such as raw materials or the labor hours billed to one client job. Overhead supports the whole business, so no single unit of output carries it.

The line blurs in a few common spots:

• Production utilities: Electricity for a production facility counts as direct if you meter it by production line. Otherwise, it's overhead.
• Sales pay: A salesperson's base pay is overhead. Commission rises with each sale, so some companies treat it as a direct selling cost.
• Shared software: A tool your delivery team and admin team both use is overhead unless you can split usage by project.

The deciding question is whether you can reasonably trace the cost to a unit of output. That answer changes your margins. Direct costs flow into cost of goods sold (COGS) and set your gross margin, while overhead sits below gross profit and determines operating profit.

Tag each new vendor as overhead or direct when you set it up, so your gross margin reflects true production cost.

Overhead costs vs. operating expenses

Operating expenses and overhead overlap so much that most people use them interchangeably. Operating expenses (OpEx) is the line item on your income statement. Overhead is the management term for an indirect cost, and manufacturers can also carry some of it inside COGS as manufacturing overhead.

Counts as both

• Rent for your headquarters
• Accounting and legal fees
• Admin and HR salaries

Where they differ

• Factory rent and floor supervisor pay are overhead that manufacturers record inside COGS.
• Sales commissions sit in OpEx, but many teams treat them as a direct selling cost.

If a cost sits in COGS, check whether it's manufacturing overhead before you count it as direct.

Types of overhead costs

You can group overhead two ways: by how the cost behaves and by which business function it supports. Behavior tells you how a cost moves as activity changes. Function tells you which team owns it and who to ask about a charge.

Fixed overhead

Fixed overhead stays the same every period, however much you sell. Rent, insurance premiums, annual software contracts, and salaried admin staff all fall here.

In practice, fixed often means committed. An annual SaaS contract or 12-month vendor agreement locks in spend until renewal, even if usage drops 3 months in. Track every renewal date, because that date is your chance to renegotiate the contract and change the number.

Variable overhead

Variable overhead rises and falls with business activity. Shipping supplies, payment processing fees, usage-based software, travel, and some contractor spend all move this way.

Variable overhead tends to arrive as dozens of small card transactions, each too minor to notice alone. That makes it the hardest type to see in aggregate. Code these charges as they post, or you'll only see the total after the month closes.

Semi-variable overhead

Semi-variable overhead combines a fixed base with a usage component. Phone plans, utilities, seat-based software, and cloud hosting with a committed minimum all work this way.

Per-seat pricing is the one to watch as you hire. A tool billed per user looks flat while headcount holds steady. Once hiring starts, every new employee adds a seat to several tools at once, so review seat counts against headcount each quarter.

Administrative, selling, and manufacturing overhead

The function view sorts overhead by the team it supports:

• Administrative overhead: Office costs, finance, HR, legal, and general software like email and payroll tools
• Selling overhead: Marketing tools, brand ad spend that isn't tied to specific sales, and sales team software and travel
• Manufacturing overhead: Indirect factory costs such as equipment depreciation, facility utilities, and floor supervisors

Manufacturing overhead matters mostly if you make physical goods. For a service or software business, administrative and selling overhead make up nearly all of it.

Tag each overhead line with a behavior type and a function, and you'll know how it will move and who owns it.

Examples of overhead costs for small businesses

Small business overhead costs cluster in the same eight categories, whatever you sell. The mix is what changes from one company to the next. Two hypothetical companies show how it shifts.

Marketing agency example

Start with a 25-person marketing agency that leases a small office.

Rent and admin salaries make up $26,500 of the agency's $39,000 total, and both are fixed. Software and travel run through the most cards and vendors, which makes them the agency's most controllable lines.

Software startup example

Now take a 40-person software startup with a hybrid team and a coworking space.

Software is the startup's second-largest line at $11,500, and per-seat pricing means it grows with every hire. Admin salaries are fixed, so the startup's easiest savings sit in software seats and travel.

Company overhead changes shape as you scale. Each new hire adds software seats and often a new cardholder. Each new team brings its own vendors, and each vendor adds a renewal date to your calendar.

Set up categories and owners while your vendor list is short, because a new vendor is easiest to code on day one.

How overhead costs appear on financial statements

On the income statement, overhead usually lands in operating expenses below gross profit. You'll see it split into lines like SG&A or R&D. Manufacturing overhead works differently, since it's absorbed into inventory and hits COGS when you sell the goods.

Income statement

A simplified income statement for a hypothetical software company shows where overhead lands.

Every dollar of overhead in those three operating lines comes straight out of operating income.

Balance sheet

On the balance sheet, overhead has no line of its own. It shows up in five places:

• Prepaid expenses: Annual software paid up front and prepaid insurance sit here, then move to expense month by month.
• Accrued liabilities: Costs you've incurred but haven't been billed for, like a month of legal work, land here.
• Accounts payable: Vendor bills you've received but haven't paid land here.
• Inventory: Manufacturers capitalize some overhead into inventory until the goods sell.
• Fixed assets: Depreciation on office equipment moves part of each asset's cost into overhead expense every period.

Timing is where overhead hides. For example, a $24,000 annual contract paid up front looks like one big hit, though its true cost is $2,000 a month. Unbilled accruals work the other way and understate overhead until the invoice arrives.

Spread prepaid contracts across their terms and accrue known costs monthly, so each month shows its true overhead.

How to calculate overhead costs

Total overhead cost is the sum of every indirect expense in a period. Run the calculation monthly so it lines up with your close.

1. List and categorize your indirect expenses

Pull one month of expenses from your accounting system, card statements, and vendor bills. Tag each line as overhead or direct using the zero-sales test. Anything you can't trace to a product or client job goes in the overhead column.

2. Add up total overhead

Add every overhead line for the period to get your total. Convert prepaid and annual contracts to a monthly amount first, so a $12,000 annual contract counts as $1,000 a month. Your total then reflects your true monthly run rate.

3. Compare overhead to sales

Overhead percentage shows how much of each sales dollar goes to overhead. To calculate overhead cost, use this formula:

Overhead percentage = Total overhead / Total sales for the same period * 100

To judge whether your number is high, compare your overhead ratio against prior months and against companies in your industry. A steady rise over several months is your cue to review your biggest overhead categories.

How to reduce overhead costs

The fastest savings at a scaling company come from visibility and control over recurring indirect spend. When you plan how to reduce overhead costs, pair each lever with a way to see the spend first. Start with the levers that touch the most transactions, since that's where small leaks add up.

1. Categorize and code every recurring indirect expense

Set up a short list of general ledger (GL) categories for overhead, such as software, professional services, facilities, and travel. Code every card transaction and bill to one of them as it posts. Coding at month-end means rebuilding 3-week-old charges from memory.

With coding done daily, you can see overhead by category and department on any day of the month.

2. Set category restrictions on company cards

Limit each card to the merchant categories its holder needs. A software-only card for tool owners and a travel-only card for frequent travelers cover most cases. Add a monthly spend limit to each card, such as $500 for a team lead's software card.

Unplanned overhead gets declined at swipe, so there's nothing to chase during reconciliation.

3. Find and cancel unused subscriptions

Audit recurring software charges every quarter. Look for duplicate tools that do the same job, seats with no login in the past 30 days, and tools nobody claims.

Assign an owner to every subscription, and make that person responsible for renewing or canceling it. A tool without an owner renews by default.

4. Catch vendor renewals before they auto-renew

Keep a calendar of every contract end date and notice period. Set each reminder at least 30 days before the notice deadline, so you have time to review usage and pricing.

Use that window to renegotiate price or drop to a lower tier.

5. Consolidate vendors and negotiate contracts

Combine vendors and tools wherever two products do the same job. For example, you might find two project management tools or three e-signature subscriptions. Where usage has held steady for 12 months or more, ask for multi-year or volume pricing.

Fewer vendors also mean fewer bills to code and fewer renewals to track.

6. Review overhead on a monthly cadence

Compare overhead by category against budget every month. Flag any category that grows faster than revenue or headcount for two months in a row. Your monthly overhead review should check four items:

• New recurring vendors added since your last review
• Renewals coming up in the next 60 days
• Cards with no activity in the past 30 days
• Categories running over budget

Close each review by giving every flagged item an owner and a due date.

See and control your overhead in real time with Ramp

At a scaling company, overhead lands on dozens of cards, in subscriptions that renew on their own, and in vendor bills that arrive weeks late. Each source lives in a different system. You usually can't see the full picture until month-end.

Ramp Expense Management gets rid of expense reports and month-end receipt chasing by capturing every card transaction at the point of sale. Employees send receipts by SMS, email, Slack, or the app, and Ramp auto-codes each one to your categories and syncs it to your books. Policy Agent, an always-on AI reviewer trained on your real expense policy, checks every transaction and surfaces only genuine exceptions.

This is what overhead control looks like with Ramp:

• Block unplanned purchases at swipe: Set merchant-category restrictions and spend limits on each Ramp corporate card. Out-of-policy overhead gets declined before it posts.
• See indirect spend by category: Ramp auto-codes 90% of card transactions, so your overhead categories stay current in real time.
• Spot recurring software and vendor charges: View recurring spend in one place, then assign owners and act before renewals hit.
• Catch more out-of-policy spend: Policy Agent catches 7x more out-of-policy spend than traditional rule-based systems.

Try an interactive demo to see how Ramp helps you see and control overhead as it happens and why companies that use Ramp save an average of 7.5% a year across all spending.