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What is overhead

Also known as: overhead costs, indirect costs, operating overhead, general and administrative expenses, overhead per hour

Definition

Overhead is the indirect cost of running a business, like rent, bookkeeping, insurance and admin salaries, that cannot be traced to one product or customer.

Why it matters

Overhead grows quietly, one software subscription, a bigger office or one more admin hire at a time, and every addition raises the bar that each month's gross profit has to clear.

Common mistakes

Adding recurring costs on the strength of hoped for revenue instead of signed customers.

Related terms

Worked exampleIllustration

A design studio's monthly overhead

Standing monthly costs

  • Rent₪6,000
  • Bookkeeping₪1,500
  • Software₪1,200
  • Insurance₪500
  • Phone and internet₪300
  • Part time office manager, employer cost₪6,500
  • Total overhead₪16,000

Not overhead

  • A freelance designer paid per project
  • Stock images bought for one client
  • The designers' hours on client work

Steps

  1. Billable hours: three people × 100 hours a month.300

  2. Overhead per billable hour: 16,000 ÷ 300.₪53.3

  3. A designer's direct cost is ₪80 an hour, so the price floor, before any profit, is 80 + 53.3.₪133.3

Any price under about ₪134 an hour loses money even when the studio is fully booked. In a month with no projects, the ₪16,000 is still due.

Illustration

The bar every billable hour must clear

Every month, with sales or without

  1. Rent+₪6,000
  2. Bookkeeping+₪1,500
  3. Software+₪1,200
  4. Insurance+₪500
  5. Phone and internet+₪300
  6. Part time office manager+₪6,500
  7. Total overhead₪16,000

Overhead: ₪16,000 a month.

One billable hour

  1. Designer's direct cost₪80
  2. Share of the overhead+₪53.3
  3. Price floor₪133.3

Price floor: ₪133.3 an hour.

Overhead is ₪16,000 a month. Spread over 300 billable hours, that is ₪53.3 an hour, so the price floor is ₪133.3 an hour before any profit. In a month with no projects, the ₪16,000 is still due.

Take a standing cost away and watch the bar drop:

The studio's standing monthly costs, then one billable hour: the designer's direct cost plus that hour's share of the overhead is the lowest price that does not lose money.

Overhead or direct cost?

Overhead

Keeps the business open, whatever it sells. Due even in a month with no projects.

  • Studio rentPaid every month, whichever projects come in.
  • BookkeepingServes the whole business, not one job.
  • Software for the whole studioUsed on every project and tied to none of them.
  • Part time office managerRuns the office and bills no client.

Direct cost (COGS)

Leaves with one job or one sale. No job, no cost.

  • A freelance designer paid for one projectHired for this project only, gone when it ends.
  • Stock images bought for one clientBought for one client and used in one job.
  • The client's first year of hostingBought for this client's site, part of the job's cost.
  • The designers' hours on client workEach hour can be traced to the job it was spent on.
The studio's costs from the overhead and COGS examples, sorted. The test: can you trace the cost to one job or one sale?

Definition

Overhead is the cost of running the business that cannot be economically traced to a specific product, job or customer: rent, bookkeeping, insurance, software, phone and internet, and the salaries of people who do not work on client jobs. Management accountants define it by traceability, not by how it behaves, so overhead can be fixed, variable or semi variable, even though most of it behaves as fixed and is still due in a month with no sales. What is not overhead: materials, subcontractors paid per job and the hours of whoever does the client work, which belong in the cost of sales. On an Israeli P&L, administrative overhead sits in the general and administrative expenses line, and part of the selling and marketing expenses is overhead too. Gross profit is what pays for it, so a month where sales look fine can still lose money if gross profit does not clear the overhead. In a service business the most useful number is overhead per billable hour, monthly overhead ÷ billable hours, which is what each hour must bring in on top of its direct cost. In nonprofits and in public funding the Hebrew term for overhead has a defined meaning of its own, the ongoing costs of running the organisation, and government grant and tender rules cap how much of it may be charged.

Why it matters

Adding overhead ahead of revenue that is not yet signed is the risky move: if sales arrive late, the costs stay, and the business is left without enough contribution margin to carry them. A new admin salary costs more than the gross salary. The employer adds National Insurance, pension and severance contributions, often a study fund, and recuperation pay, which the general extension order makes mandatory once the employee completes a first year. Price every new hire at its full employer cost. Educational material, not tax or legal advice.

Directly related: Gross Profit, COGS, Break-even point.

How to calculate the overhead rate

The overhead rate divides overhead by a base you choose. For a small business the simplest base is revenue: monthly overhead divided by the same month's revenue, times 100, is the share of every shekel of sales that goes to running the business, before any profit.

  1. Add up one month of overhead: rent, bookkeeping, insurance, software, phone and internet, and the salaries of people who do not work on customer jobs.
  2. Divide by the same month's revenue and multiply by 100. In the illustrative studio above, if the month brought in ₪60,000, the rate is 16,000 ÷ 60,000 × 100, about 26.7%.
  3. In a service business, also divide by the hours customers pay for: 16,000 ÷ 300 billable hours is ₪53.3, the overhead every billed hour has to carry.

Read the rate over several months, not one. Revenue moves more than overhead does, so a slow month pushes the rate up even when nothing was added.

Examples of overhead in a small business

Typical overhead in a small business, each item hard to tie to a single product or customer:

  • Rent, municipal tax (arnona) and electricity for the premises
  • Bookkeeping and the accountant's fees
  • Business insurance
  • Software subscriptions
  • Phone and internet
  • Salaries of admin staff, at the full employer cost

Improvement tips

  • Before any new recurring cost, work out its full monthly cost, including the employer costs on top of a salary, and check your contribution margin and how long it will take to reach the break-even point again.
  • Work out overhead per billable hour and use it as the floor under your hourly price.
  • Try a new overhead cost on a short commitment first, with a contractor or a shared space, before you sign for years.
  • Go through the standing orders and card charges once a quarter and cancel what nobody uses.

Common mistakes

  • Letting small subscriptions and office costs pile up without a regular review.
  • Treating overhead and fixed costs as the same thing. Overhead is defined by the fact that it cannot be traced to a sale, and some of it moves with activity.
  • Testing sales against overhead. Gross profit is what has to cover the overhead, not sales.
  • Pricing a service hour from its direct cost alone and forgetting the overhead each hour must carry.

Related terms

FinanceBeginner

Gross Profit

Gross profit is revenue minus the cost of goods sold (COGS): what is left from sales after goods, materials and direct labour. Rent and salaries come from it.

FinanceBeginner

COGS

COGS (cost of goods sold) is the cost of the goods or services sold in a period: goods, materials and direct labour. Revenue minus COGS is gross profit.

FinanceBeginner

Break-even point

The break-even point is the sales level where revenue covers all costs, no profit and no loss: fixed costs ÷ what each sale leaves after variable costs.

FinanceBeginner

P&L

A P&L (profit and loss statement, or PnL) sums up a business's revenue and expenses for a period and shows if it made or lost money. Profit on it is not cash.

FinanceBeginner

Net Profit

Net profit is what a business keeps from revenue after every expense, cost of sales, running costs, interest and tax. It is the bottom line, not cash.

FinanceBeginner

Revenue

Revenue is everything a business sold in a period, before any costs and without the VAT on the invoice. It is the P&L's top line, not profit and not cash.

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Quick check

Which of these is overhead?

Choose an answer

Frequently asked questions

Do I need to understand overhead before starting a business?
Yes. Overhead is what it costs to keep the doors open whether or not you sell. Knowing it tells you how much gross profit you need each month just to stand still.
When does overhead first become relevant for a new business?
The moment you commit to a recurring cost, such as rent, a software licence or a part time employee. Every such commitment raises the bar before the first sale.
How do I plan overhead for a new business?
List only what you cannot operate without, such as bookkeeping, a phone, insurance and basic software. Keep contracts short and avoid a large office until revenue is steady.
Can a new business run with zero overhead?
Almost, but never exactly zero. Even a one person business working from home pays for bookkeeping, a phone and insurance. The aim is overhead small enough that a slow month does not threaten the business.
Why does overhead matter for a business that is already running?
It is the cost that stays when sales fall. High overhead makes a seasonal dip or a slow quarter dangerous, because gross profit shrinks while the overhead does not.
What goes wrong when a business ignores its overhead?
Small costs pile up, unused subscriptions and extra services, and slowly raise the break-even point until an ordinary month no longer covers it.
How do I start managing overhead without stopping daily work?
Once a month, go through the bank statement and card charges and mark every recurring cost. An hour is usually enough to find something to cancel.
How can a business cut overhead when sales slow down?
Renegotiate the rent, move to remote work or a shared space, cancel duplicate software and, where it fits, replace fixed roles with people paid per job. Cut what the customer never sees first.
What does overhead mean in plain words?
It is the cost of running the business that is not tied to any one sale: rent, bookkeeping, insurance, phone bills and admin salaries.
Is overhead complicated to calculate?
No. Add up every monthly cost that you cannot trace to a specific product, job or customer. In a service business, divide the total by your billable hours to see what each hour must carry.
Why do grants and tenders talk about overhead?
In nonprofits and in public funding, overhead has a defined meaning: the ongoing costs of running the organisation. Israeli government grant instructions and the tender regulations cap how much overhead may be charged, so read the terms of the specific call. Educational material, not tax or legal advice.
What is the difference between overhead and the cost of sales?
The cost of sales is what it took to make or deliver what you sold: materials, subcontractors per job and the hours of whoever does the client work. Overhead is everything that keeps the business running but cannot be traced to one sale, and gross profit is what pays for it.

Sources: CIMA (Chartered Institute of Management Accountants), Official Terminology, definition of overhead, as quoted in management accounting course material, checked September 2026, National Insurance Institute of Israel (btl.gov.il), employer contributions, checked September 2026, Kol Zchut (kolzchut.org.il), recuperation pay: an employee is entitled after completing a first year with the employer, under the general extension order on the employer's share of recuperation and holiday costs, checked September 2026, Accountant General, Israel Ministry of Finance, instruction 6.1.3, limiting general and administrative expenses, checked September 2026, Israel, Mandatory Tenders Regulations, 1993, checked September 2026, AccountingTools, "Overhead rate definition" (accountingtools.com/articles/what-is-the-overhead-rate.html)

Last reviewed: 2026-09-27

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