Overhead

CALCULATING OVERHEAD AND PRICE

lan Hauff, pricing expert and small business specialist for University Outreach and Extension at the University of Missouri-St. Louis, has devised a seven-step process for calculating the all-important overhead percentage, which is shown in Fig. I-I on the following page. After the overhead percentage is determined, important pricing decisions can be made. To calculate overhead percentage, several terms must be defined. These are found in Table I-I. For instance, an overhead percentage of 220% means that for every $1.00 of direct labor billed to the customer, the business must collect an additional $2.20 ($1.00 x 220%) from that customer just to cover its cost of doing business. Thus, if a job required a direct labor wage of $8.50 per man-hour, overhead of $18.70 ($8.50 x 220%) must be added, thus totaling a direct labor cost of $27.20 per man-hour. It is at this point that many business owners are shocked to discover the large difference between the total direct labor wage and the direct labor cost.

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TABLE I-I. PRICING-RELATED TERMS. TERM Business Expenses Overhead Expenses DEFINITION All expenses found on the company’s income statement (also known as the profit and loss statement). All costs found on the income statement except for direct labor, direct materials, and costs attributable to outside subcontractors that can be billed directly to a customer’s account. Overhead expenses are absorbed by the business and factored into the selling price as a percentage of the direct labor cost. They include indirect costs such as accounting, advertising, depreciation, indirect labor, insurance, interest, legal fees, rent, repairs, supplies, taxes, telephone, travel, and utilities. Labor used to produce products and services purchased by customers. These man-hours are directly attributable to customer activity. Labor used to provide supporting services to the business such as accounting, clerical, custodial, customer services,...