You’ve probably heard it mentioned in a meeting or seen it scribbled in a budget report: an OH. It sounds like a sigh of relief, or maybe a gasp of surprise. But in the world of business, it’s neither. It’s overhead.
Most people think they understand overhead. They think it’s just the rent and the light bill. That’s a start, sure. But if you're running a company or trying to figure out why your project's margin is shrinking, a basic "rent and lights" definition is going to get you in trouble. Overhead is the silent engine—or the invisible weight—behind every single transaction a business makes.
It’s messy. It’s also everywhere.
Defining an OH Without the Corporate Fluff
So, what is an OH exactly? In the simplest terms, overhead refers to all those ongoing business expenses that aren't directly linked to creating a product or delivering a specific service. If you’re a carpenter, the wood is a direct cost. The hammer is a tool. But the monthly insurance you pay for your shop? That's an OH.
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The interesting thing about overhead is that it stays there even if you don't sell a single thing. You could have zero customers today, but your landlord still wants the rent. Your internet provider doesn't care if you're "innovating" or just watching cat videos; they want their $150. This is what accountants call "indirect costs."
It’s the stuff that keeps the lights on so you can do the work that actually makes money.
The Three Flavors of Overhead
Not all overhead is created equal. Understanding the nuances here is how you move from "I think we're spending too much" to "I know exactly where our cash is leaking."
First, you have fixed overhead. These are the predictable ones. Rent, mortgage payments, some insurance premiums, and salaries for "back-office" staff like HR or accounting. They don't wiggle much. Whether you produce 10 widgets or 10,000, these costs stay the same. It's the baseline cost of existing.
Then there’s variable overhead. This is trickier. These costs fluctuate based on how active the business is. Think about electricity. If you run a factory 24/7 during a peak season, that bill is going to skyrocket. If you’re on holiday for two weeks, it drops. It’s still overhead—because you aren't selling "electricity" to your customers—but it scales with your effort.
Finally, we have semi-variable overhead. These are the pests. They have a base cost, but they go up after a certain point. A great example is a cell phone plan with data overages or a shipping contract that has a flat monthly fee plus a per-package charge.
Why Everyone Gets the "OH Rate" Wrong
Calculating an OH rate is where the math gets real. And where most small business owners start to sweat. To figure out if you're actually profitable, you have to allocate these indirect costs to your products.
If it costs you $10 in materials and labor to make a shirt, and you sell it for $20, you didn't make $10. You forgot about the OH. You have to take all your monthly overhead and divide it by something—usually labor hours or machine hours—to find out how much "overhead" is riding along on every single shirt.
If your overhead is $5,000 a month and you work 500 hours, every hour of work needs to "pay" $10 toward the overhead. If you don't bake that into your pricing, you’re basically paying your customers to buy your stuff. Honestly, it’s the number one reason startups fail in their first three years. They focus on the "sexy" costs like marketing and ignore the boring, soul-crushing costs of just staying open.
Real World Examples of Hidden Overhead
Let’s look at a modern tech company. You’d think their overhead is low because they don't have a factory, right? Wrong.
- SaaS Subscriptions: Slack, Zoom, Jira, AWS, Salesforce. These monthly "micro-transactions" pile up until you're spending $50k a month on software just to communicate about the work you're supposed to be doing.
- Legal and Compliance: If you're in a regulated industry, your legal retainers are a massive OH. You aren't selling "legal advice," but you can't sell your product without it.
- Employee Perks: That "free" cold brew and the ping-pong table? Overhead. Every bit of it.
In 2023, many tech firms realized their an OH had spiraled out of control. The "year of efficiency" that Meta and others talked about was really just a massive, painful exercise in cutting overhead that no longer served the core mission of the company. When revenue growth slowed, the fixed costs became a noose.
The Manufacturing Perspective
Contrast that with a traditional manufacturing plant. Here, an OH is often tied to "absorption costing." This is a method where the cost of a manufactured item includes all variable costs and all fixed costs.
It gets complicated. If the plant produces fewer items than planned, the "overhead per unit" goes up. This creates a weird incentive for managers to keep the machines running even if there isn't demand, just to keep the "cost per unit" looking low on paper. It’s a dangerous game. It leads to bloated inventory and wasted cash.
How to Manage Your OH Without Killing the Vibe
You can't just slash overhead to zero. If you stop paying for the internet, your business dies. If you stop paying for accounting, the IRS comes knocking.
The goal is optimization, not elimination.
Start by categorizing every expense. Is it essential for operations, or is it nice to have? Many companies use a "Zero-Based Budgeting" approach every few years. This means instead of just looking at last year's budget and adding 5%, you start at zero and justify every single dollar of overhead from scratch.
It’s exhausting. But it’s effective.
You’ll find subscriptions for people who left the company two years ago. You’ll find insurance policies that overlap. You’ll find that you’re paying for a premium office space that nobody actually goes to because everyone wants to work from home anyway.
The Nuance of "Good" Overhead
Believe it or not, some overhead is good.
Investing in a high-quality Project Management Office (PMO) is technically an OH expense. They don't build the product. They don't sell the product. But they make the people who do build and sell much more efficient. If spending $100k on a great manager saves $500k in wasted labor time, that’s "good" overhead.
Don't be the person who cuts the coffee budget and loses $1 million in talent because the office feels like a prison. Nuance matters.
Common Misconceptions About Overhead
A big one: "Overhead is always bad."
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Not true. High overhead can sometimes mean a company is investing in its future. A massive R&D department is overhead until they invent the next iPhone. The trick is knowing the difference between investment-heavy overhead and just plain old waste.
Another misconception is that an OH is only for big corporations. If you’re a freelancer working from your couch, you still have overhead. Your laptop, your Adobe subscription, your portion of the electric bill—that’s all overhead. If you aren't accounting for it in your hourly rate, you’re undercharging yourself.
Steps to Take Right Now
If you want to get a handle on your an OH, stop reading for a second and look at your bank statement.
- Identify the "Ghost" Subs: Look for those $14.99 or $99 monthly charges for tools you haven't logged into in three months. Cancel them. Now.
- Calculate Your Overhead Rate: Take your total monthly indirect costs and divide them by your total monthly revenue. If that percentage is creeping up month-over-month, you have a problem.
- Negotiate Fixed Costs: Many people assume rent or insurance is set in stone. It’s not. In the current commercial real estate market, many landlords are willing to negotiate rather than have a vacant building.
- Review Labor Allocation: Are your "direct" employees spending 40% of their time on "indirect" tasks like administrative meetings or filing? If so, your overhead is actually higher than your books suggest.
Understanding an OH isn't about becoming a bean counter. It's about clarity. When you know exactly what it costs to keep the doors open, you can make bolder decisions about where to invest and when to pull back. It’s the difference between flying a plane with working gauges and just hoping you have enough fuel to reach the runway.
Keep an eye on the numbers, but don't let them paralyze you. Use them as a roadmap.
Next Steps for Implementation:
Start by pulling your Profit and Loss (P&L) statement from the last quarter. Isolate every expense that doesn't change based on your sales volume. This is your baseline. Once you have that number, divide it by your total billable hours for that same period. This gives you your "Break-Even Hourly Overhead." Use this number the next time you draft a proposal or set a price—it ensures you're covering the cost of "being in business" before you even think about profit.