So, what makes overhead costs so different from these others?
We've put together a simple guide to help you understand what overhead cost is, some examples, and how to calculate it. It’s an important part of learning how to manage costs in a restaurant business. and avoiding being a part of the high restaurant failure rate.
We’ve also included a free downloadable overhead calculation worksheet to make it easier to calculate.
Overhead Cost Definition: What Does Overhead Mean?
Overhead costs, or operating expenses, are costs associated with running a business that aren't related to production.
These are costs required for a business to function, regardless of its level of success or number of orders. These include things like facility and utility costs, supplies not related to production, and if applicable, eCommerce business insurance.
What Are Overhead Expenses?: Overhead Costs Include
There are three types of overhead expenses, each with its own associated costs
- Fixed overhead cost. Fixed costs are costs that stay the same each month. These costs include rent payments, salaries, insurance, property taxes, and more. They are usually established with a contract that outlines a given time period where they will not change rates. These costs are an important factor in calculating a business's prime cost.
- Variable overhead cost. Variable costs increase or decrease based on the business' workload. These costs include utilities related to production, wages, raw materials inventory, and sales commissions. The better your business does, the more your variable costs will increase. Ensuring these costs don't get out of hand is vital in maintaining a good restaurant profit margin.
- Semi-variable overhead cost. Semi-variable, or semi-fixed, costs are composed of a mixture of fixed and variable costs. If no production takes place, a fixed cost is incurred. If production ramps up, the expense also increases. These costs include equipment depreciation, staffing, overtime, and bills like cell phones that may incur extra costs.
Overhead Costs for Small Businesses
Overhead costs can be prohibitive for many small businesses and startups. Keeping these costs low can help a business survive slow periods.
Here are some tips on how to do that:
- Create a list of expenses. You can't make decisions regarding your business's costs if you don't know them. Create a list of recurring expenses (like restaurant hood cleaning) and track them consistently. These should also be present in your restaurant balance sheet.This will also help you calculate some important numbers like your cost of goods sold.
- Look at your rent or lease. Lease rates are an expense that is often too high for small businesses to cover when business is slow. If you can, try to renegotiate the rate or sublet parts of your facility that you don't use. If that doesn't work, it may be time for a change. Lowering rent and utilities by finding a smaller location may sound like a big move, but it may be necessary.
- Adjust staffing levels. Lowering salary costs is one of the most common ways to reduce overhead. Limiting this expense doesn't mean firing staff. You can lower costs by using more hourly workers and using them wisely. Instead of having extra staff during slow periods, adjust work schedules to get the best results from your team. You can also invest in a perpetual inventory system like BinWise Pro. It can cut labor cost spent on beverage inventory up to 85% and increase your profits.
Overhead Cost Examples
There are many overhead costs a company will incur depending on the nature of the business.
Here are 10 common overhead costs for bars:
- Business insurance
- Office supplies
- Business licenses
- Alcohol licenses
- Property taxes
- Equipment repairs
Overhead Cost Formula & Total Overhead Cost Formula
Calculating your overhead cost, or total overhead cost, is as simple as adding all costs not related to making drinks or food together. These include things like rent, utilities, salaries, etc.
More importantly, you should also calculate your overhead rate, which compares your overhead costs to revenue.
The overhead rate formula is:
Overhead Rate = Overhead Costs / Income From Sales
How to Calculate Overhead Cost
Here we’ll lay out how to calculate overhead cost then use the overhead rate formula above. This will help us plan ways to cut costs and increase revenue.
For this example, let's say last year we decided to open a bar called JJ's British Pub. We're looking to find our total overhead costs and our overhead rate for the year.
We've determined that our overhead costs consist of the following:
- Rent: $14,000
- Utilities: $8,045
- Taxes: $9,400
- Alcohol licenses: $1,000 (this includes only the license to sell alcohol, not your license to bartend)
To get our total overhead cost, let's add them up.
Total Overhead Cost = Rent + Utilities + Taxes + Licenses
Total Overhead Cost = $14,000 + $8,045 + $9,400 + $1,000
Total Overhead Cost = $32,445
We discover that the total overhead cost for the bar last year was $32,445. Now we need to know what that means against our revenue. We've looked at our POS system and found that our sales for last year were $235,000.
Now we’ll use these two numbers in the overhead rate formula from above.
Overhead Rate = Overhead Costs / Income From Sales
Overhead Rate = $32,445 / $235,000
Overhead Rate = .138 or 13.8%
Our overhead rate last year was 13.8%. That means we spent 13.8 cents on overhead costs for every dollar we made.
Overhead Calculation Worksheet
You can also calculate your restaurant or bar’s overhead costs using this free downloadable overhead calculation worksheet.
Once you download it, you can edit the cells and it'll do the calculations for you. Input the overhead costs incurred for each quarter and let it calculate the total for you. You’ll see an example of a bar's overhead costs for reference. Once you understand how it works, try entering your costs and doing some calculations.
Did That Go over Your Head?
Overhead costs make up a large portion of a restaurant or bar's total costs. They add up quickly and keeping them from getting out of hand is vital if you're going to continue to grow your business. Using the formula and tools above, you're on your way to controlling your costs.