How to Calculate Overhead Rate in QuickBooks

Calculating overhead rates in QuickBooks can be tricky for small business owners.

This article will walk you through a step-by-step process to accurately calculate your overhead rate using QuickBooks' built-in tools and reports.

You'll learn key concepts like identifying overhead costs, choosing allocation metrics, setting up overhead accounts, and benchmarking rates against industry standards. Whether you're looking to price products properly or simply understand where your money is going, this guide has you covered.

Introduction to Calculating Overhead Rates in QuickBooks

Accurately calculating overhead rates in QuickBooks is critical for businesses to understand their true operating costs and set competitive pricing for their products and services. Overhead costs refer to expenses that are not directly tied to production, such as rent, utilities, and administrative salaries. By properly tracking overhead rates, businesses can benchmark performance over time and across locations.

Understanding the Overhead Rate Concept

The overhead rate is the ratio of total overhead costs to direct costs over a period of time. It is expressed as a percentage. Some examples of common overhead costs for small businesses using QuickBooks include:

Rent
Utilities like electricity and internet
Administrative, marketing, and management salaries
Software subscriptions
Equipment maintenance and repairs

To calculate the overhead rate in QuickBooks, add up all overhead costs for a period and divide by the total direct costs like materials and labor over the same period.

The Importance of Accurate Overhead Rate Calculation

There are several key reasons to properly track overhead rates in QuickBooks:

Improve pricing decisions: Understanding true overhead costs allows businesses to incorporate those expenses into pricing to achieve profitability targets.
Identify cost centers: Breaking down overhead costs by department can highlight which areas of the business are more costly to operate.
Benchmark performance: Comparing overhead rates over time and across business units allows for better cost control.

What is a Typical Overhead Rate?

While overhead rates vary significantly across industries, most small businesses have overhead rates between 20-60%. Factors that influence overhead costs include:

Facilities expenses from renting vs. owning
Regional cost of living differences
Technology investments
Economies of scale for larger companies

Careful overhead rate analysis provides actionable insights into operational efficiency. Accurately calculating this metric is key for small businesses using QuickBooks to improve profitability.

How do you calculate overhead in Quickbooks?

QuickBooks calculates your overhead rate automatically based on your income and expenses. Here's a quick rundown of how to find and understand your overhead rate:

View Your Overhead Rate

Go to the Reports menu and select Profit & Loss.
Scroll down to see your Total Income and Total Expenses.
Just below that, you'll see Overhead Rate - this shows overhead as a percentage of income.

For example, if your overhead expenses were $20,000 and total income was $100,000, your overhead rate would show as 20%.

What Goes Into Overhead

Overhead includes all indirect operating expenses, such as:

Rent
Utilities
Insurance
Office supplies
Salaries for support staff
Equipment costs
Accounting and legal fees

So your overhead rate gives you a quick snapshot of how much these indirect costs are eating into your profits.

Why Track Overhead Rate

Knowing your overhead rate helps you:

Set prices and budgets
Assess profitability of products/services
Identify expense reduction opportunities
Compare to industry benchmarks

So keep an eye on overhead, and take action if it creeps up too high. The lower the better for your bottom line profits.

What is the formula for overhead rate?

The overhead rate formula is:

Overhead Rate = Total Overhead Costs / Total Direct Costs

Where:

Total Overhead Costs: This includes all indirect operating costs incurred by a business, such as administrative expenses, rent, utilities, insurance, depreciation, etc.
Total Direct Costs: This includes all costs directly related to production, such as direct material, direct labor, direct machine costs, etc.

For example, if a company has $200,000 in total overhead costs and $1,000,000 in total direct costs during a period, the overhead rate would be:

Overhead Rate = $200,000 / $1,000,000 = 20%

This overhead rate is then used to allocate the overhead costs across departments, products, services, projects, etc. based on each one's share of direct costs.

So if Product A has $100,000 of direct costs, it would be allocated 20% x $100,000 = $20,000 of the total overhead costs.

The key things to remember about overhead rate are:

It allows a business to distribute indirect costs across areas based on activity levels
It is calculated by dividing total overhead by total direct costs over a period
It may vary from period to period as overhead and activity fluctuate
An accurate overhead rate helps businesses understand true costs and pricing

How do you calculate the amount of overhead allocated?

To calculate the amount of overhead allocated in QuickBooks, you first need to compute your overhead rate. This is done by dividing your total overhead costs by the total number of direct labor hours for a certain period.

For example, if your total overhead costs last month were $10,000, and the total direct labor hours were 4,000, your overhead rate would be:

$10,000 / 4,000 hours = $2.50 per direct labor hour

This means for every hour of direct labor needed to manufacture or provide your products/services, you need to allocate $2.50 worth of overhead costs.

So if a particular job or product required 100 direct labor hours, you would calculate the allocated overhead as:

100 hours x $2.50 per hour = $250

The $250 would be the amount of overhead costs allocated to that particular job or product.

Some key things to note about overhead allocation:

Overhead costs include indirect expenses like rent, utilities, administrative salaries, etc.
Direct labor refers to the employees directly involved in production. Track these hours.
Re-calculate the overhead rate periodically as expenses change.
Apply the overhead rate consistently across jobs and products.

Having an accurate overhead allocation rate helps you understand the true cost and profitability of your jobs, products, and services. This is critical pricing and cost management.

What is the formula for applied overhead?

Applied overhead is calculated by multiplying the predetermined overhead rate by the allocation base.

The predetermined overhead rate is calculated by dividing estimated total overhead costs by the estimated total allocation base. For example, if a company estimates $100,000 in total overhead costs and 50,000 direct labor hours for the period, the predetermined overhead rate would be $2 per direct labor hour ($100,000/50,000 hours).

The allocation base is the activity that is driving the overhead costs, usually direct labor hours or machine hours. It is used to assign portions of the overhead costs to individual jobs.

For example, if the predetermined overhead rate is $2 per direct labor hour, and a specific job required 100 direct labor hours, the applied overhead for that job would be calculated as:

Predetermined overhead rate = $2 per direct labor hour

Direct labor hours for the job = 100 hours

Applied overhead = Predetermined overhead rate x Direct labor hours
= $2 per hour x 100 hours
= $200

So in this example, $200 of overhead costs would be applied to the job.

The formula can be summarized as:

Applied Overhead = Predetermined Overhead Rate x Allocation Base

Where:

Predetermined Overhead Rate = Estimated Total Overhead Costs / Estimated Total Allocation Base
Allocation Base = Direct Labor Hours or Machine Hours for the job

This formula allows a company to allocate overhead costs to jobs based on the activities that are driving those costs. It is an important component of determining the full cost of production.

How to Calculate Total Overhead in QuickBooks

Calculating total overhead costs and overhead rates in QuickBooks can help businesses understand their full operating costs. Here are the key steps:

Identifying Overhead Costs

Overhead costs are operating expenses not directly tied to production. Common examples include:

Rent
Utilities
Insurance
Office supplies
Equipment costs
Administrative salaries

Review your Chart of Accounts in QuickBooks to identify accounts tracking these types of expenses.

Running an Overhead Report in QuickBooks

Generate an Overhead Expense by Vendor Summary report covering the desired time period. This compiles overhead expenses from accounts identified as related to overhead.

Determining the Overhead Cost Base

Total the expenses from the Overhead Report to calculate total overhead costs for the period.

The overhead cost base depends on how the rate will be used:

Labor hours: Total overhead costs / Total labor hours
Labor costs: Total overhead costs / Total labor costs
Unit production: Total overhead costs / Total units produced

Incorporating Material Overhead Cost

Calculate material overhead separately based on costs like:

Material handling
Freight
Storage

Add the material overhead total to the operating overhead costs before determining overhead rates.

Following these steps in QuickBooks streamlines overhead cost and rate calculations for better financial control.

Allocating Overhead Costs to Calculate the Overhead Rate

Allocating overhead costs is an important step in determining your company's total overhead rate. This rate allows you to accurately assign overhead costs to jobs, products, or services. Here's an overview of the key steps:

Choosing an Allocation Metric

The first step is selecting an appropriate allocation metric to divide up your overhead costs. Common options include:

Labor hours - Best for labor-intensive businesses. Divides overhead based on labor time spent.
Machine hours - Best for manufacturing. Divides overhead based on machine runtime.
Units produced - Best for high-volume manufacturing. Divides overhead by total units made.

Choose a metric that best reflects what drives your overhead costs. Using an inaccurate metric will skew your overhead rate.

Calculating the Overhead Rate

Once you've chosen a metric, the overhead rate formula is:

Overhead Rate = Total Annual Overhead Costs / Total Annual Allocation Metric

For example, if a manufacturer has $400,000 in annual overhead costs and 50,000 total yearly machine hours, its overhead rate is:

Overhead Rate = $400,000 / 50,000 hours = $8 per machine hour

This $8/hour can now be used to assign overhead to individual jobs.

Analyzing the Overhead Rate

Compare your overhead rate to industry benchmarks to analyze if it is reasonable. Rates too high or low can signify inefficiencies in operations.

Additionally, break down overhead by department or product line to identify where a disproportionate amount may be coming from. This allows you to target specific areas for potential overhead savings.

Careful allocation and analysis of overhead is key for accurate cost assignments and sound business financials. Calculating your company's overhead rate is an important first step.

Tracking and Using Overhead Rates in QuickBooks

QuickBooks provides useful tools for tracking overhead expenses and incorporating overhead rates into pricing decisions. Here are some tips:

Setting Up Overhead Accounts in QuickBooks

Create separate General Ledger (GL) accounts for each type of overhead expense, such as one for rent, utilities, office supplies, etc. This allows you to track costs granularly.
Set up overhead accounts as "Other Expense" accounts in QuickBooks to keep them separate from direct costs.
Assign accurate account numbers and names so expenses are posted to the right overhead accounts.

Regularly Updating Overhead Rates

Recalculate overhead rates every month or quarter as expenses fluctuate. The formula is:

Total Overhead Expenses / Total Units Produced

As overhead costs change, the rates should be updated to reflect current figures.
Accurate overhead rates lead to precise job costing and better pricing decisions.

Incorporating Rates into Pricing Decisions

Add the overhead rate per unit as a line item cost when calculating pricing for products, services, and jobs.
Overhead costs impact profit margins. Tracking them prevents underpricing goods.
Compare overhead rates to industry benchmarks to gauge competitiveness.

Benchmarking Overhead Rates Against Industry Standards

Use QuickBooks to pull overhead expense reports and compare rates.
If overhead rate is higher than the industry, assess expenses to reduce costs.
Changes in operations, technology etc. can impact overhead rates against benchmarks.

Monitoring overhead rates continuously and factoring them into pricing is key for making sound business decisions. QuickBooks provides the necessary accounting tools to accomplish this effectively.

Potential Challenges and Solutions in Overhead Rate Calculation

Overhead costs can fluctuate significantly for businesses, making it difficult to set accurate overhead rates. Here are some common challenges with overhead rates and potential solutions:

Dealing with Fluctuating Costs

Overhead costs like rent, utilities, and administrative salaries can change month-to-month. This makes it hard to set a single overhead rate that works all year. Some strategies to handle fluctuating overhead costs include:

Calculate a rolling 12-month average cost for major overhead expense categories rather than using the actual monthly costs. This smooths out temporary spikes or dips.
Build in a buffer percentage (e.g. 10%) on top of the overhead costs to account for variability. Adjust this buffer as needed at year-end.
Review and update overhead rates quarterly rather than waiting until year-end. This allows more frequent adjustments.

Allocating Overhead to Multiple Departments

For companies with several departments, allocating shared overhead costs can be tricky. Some tips include:

Track overhead expenses that can be directly traced to each department, then allocate shared costs using an appropriate metric such as headcount, square footage, etc.
Consider usage intensity (e.g. energy consumption) to allocate utility overhead costs across departments.
If a department supports others in an overhead function (e.g. facilities), charge the other departments for those services via intercompany billing.

Setting Overhead Rates for New Products

When launching a new product, it's hard to determine overhead costs since there's no usage history. Ways to estimate new product overhead rates include:

Base estimates on the overhead rates of similar products already offered.
Initially set a higher overhead rate to build in extra buffer and adjust later as actual overhead for the new product becomes clearer.
As product matures, track actual overhead attributable to that product specifically to refine rate.

Adjusting Overhead Rates for Seasonal Variations

For businesses with significant seasonal fluctuations, develop overhead rates for peak and off-peak periods. When production or sales volume changes dramatically between seasons, overhead costs are often allocated much differently. Some tips for adjusting overhead rates by season include:

Look at past years' data to define distinct seasons and determine how overhead cost allocation differed in each one.
Categorize overhead costs as fixed or variable to determine which change based on seasonal factors.
Set overhead rates for each season separately based on historical averages.

Conclusion and Next Steps for Managing Overhead in QuickBooks

Summarizing the Essentials of Overhead Rate Calculation

Accurately calculating overhead rates in QuickBooks is key for understanding true costs and pricing appropriately. The main takeaways include:

Overhead refers to indirect operating expenses not tied to production. This includes things like rent, utilities, admin salaries, etc.
To calculate the overhead rate:
Add up total annual overhead costs
Divide by total annual direct costs (labor & materials)
Multiply by 100 to get a %
It's important to update the calculations regularly as expenses change. Breaking expenses into categories can help track where costs are increasing.
Set up separate accounts in QuickBooks to track overhead expenses for reporting visibility. Allocate overhead to jobs based on the rates.

Additional Resources for Overhead Management

To continue improving overhead management, check out these QuickBooks guides:

How to Set Up Overhead Tracking
Allocating Overhead to Jobs with Classes
Overhead Reports & Analytics

Staying up-to-date on best practices can help optimize overhead calculations.

Encouraging Continuous Learning and Adaptation

As your business evolves, continue assessing overhead rates and cost drivers. Look for ways streamline operations or reduce unnecessary expenses. Adapting your overhead calculations allows better cash flow control and pricing strategies. With the right foundations in QuickBooks, you'll have visibility to make informed decisions for the business.