How to Calculate Overhead Cost Per Hour

Understanding overhead cost per hour is a fundamental concept for any business aiming to operate sustainably and profitably. This metric represents the portion of a company’s indirect expenses allocated to each hour of work performed or produced. It helps businesses determine the true cost of delivering services or creating products, extending beyond just direct materials and labor. Accurately calculating this figure is important for setting competitive prices, developing realistic budgets, and assessing overall financial health.

Identifying Overhead Costs

Overhead costs encompass all expenses necessary for a business to operate but which are not directly tied to the production of a specific good or service. These indirect costs are incurred regardless of whether a product is manufactured or a service is rendered. Such expenses are broadly categorized into fixed and variable overhead.

Fixed overhead costs remain relatively constant regardless of the level of business activity or production volume. Examples include monthly rent payments for office or facility space, annual insurance premiums for liability or property, and the salaries of administrative staff who do not directly produce goods or services. Depreciation on equipment and property, a non-cash expense reflecting asset wear and tear over time, also falls into this category.

Variable overhead costs, in contrast, fluctuate in proportion to the level of business activity or production. Common examples include office supplies, which are consumed more frequently with increased administrative tasks, or utilities such as electricity and water, whose consumption often rises with extended operating hours or increased production. Maintenance and repair costs for equipment can also be variable, depending on usage.

Gathering Data for Calculation

Collecting the precise numerical data is the next critical step after identifying overhead categories. This process involves determining the total overhead costs and the total billable hours over a consistent period, such as a month, quarter, or year.

To ascertain total overhead costs, businesses must sum all the identified fixed and variable overhead expenses for the chosen period. This financial information is typically found within a company’s accounting records. Sources include the general ledger, detailed expense reports, bank statements showing outgoing payments, and financial statements like the income statement. Many businesses utilize accounting software to track and categorize these expenses, which can simplify the aggregation process.

Separately, determining the total billable hours for the same period is equally important. Billable hours refer to the time spent by employees or contractors directly on client projects or revenue-generating activities. Businesses often track these hours using specialized time-tracking software, which records time spent on specific tasks, or through manual timesheets and logs. Ensuring that only genuinely billable hours are included, and non-billable administrative time is excluded, is crucial for an accurate calculation.

Performing the Calculation

Once all necessary data has been accurately gathered, the calculation of the overhead cost per hour can be performed using a straightforward formula. This mathematical step provides a clear per-hour figure that represents the share of indirect costs. The formula is: Overhead Cost Per Hour = Total Overhead Costs / Total Billable Hours.

To illustrate, consider a business that incurred $15,000 in total overhead costs over a specific month and recorded 500 total billable hours during the same period. Applying the formula, the calculation would be $15,000 divided by 500 hours. This results in an overhead cost per hour of $30. This figure indicates that for every billable hour worked, the business incurs $30 in indirect expenses.

It is imperative that the total overhead costs and total billable hours correspond to the exact same time period for the calculation to be meaningful. Using costs from one quarter and hours from another would lead to an inaccurate and misleading result.

Applying the Calculation

The calculated overhead cost per hour is a powerful metric that provides valuable insights for various business decisions. It helps businesses understand the true cost of their operations beyond direct labor and materials. This understanding is fundamental for ensuring financial stability and growth.

One primary application is in setting accurate pricing for services or products. By knowing the overhead cost per hour, a business can ensure that its hourly rates or product prices not only cover direct costs but also contribute adequately to covering all indirect expenses. For instance, if a business charges $100 per hour for a service and its overhead cost per hour is $30, it knows that $70 remains to cover direct labor, materials, and profit.

Furthermore, this figure is instrumental in informed budgeting and cost management. Businesses can use the overhead cost per hour to forecast future expenses more accurately, based on projected billable hours. It also highlights areas where cost reduction efforts might be most impactful, allowing management to identify and address inefficiencies. Regularly monitoring this metric allows businesses to assess their operational efficiency and make strategic adjustments to improve profitability.