Key Takeaways
- Overhead Defined: Manufacturing overhead includes indirect costs like rent, utilities, and supervisor salaries that support production but aren’t tied to a single product.
- Why It Matters: Ignoring overhead leads to underpricing, blurred profit margins, and poor decision-making.
- Step-by-Step Breakdown: Identify all indirect costs, choose the right cost driver, calculate your overhead rate, and apply it consistently to every job.
- Avoid Costing Mistakes: Watch out for common errors like ignoring maintenance, misclassifying admin costs, or using the wrong driver.
- Real-World Relevance: HVAC and fabrication shops can dramatically improve job costing and profitability with accurate overhead allocation.
Before You Quote That Job…
I know, figuring out how to calculate manufacturing overhead isn’t the most glamorous part of running a field service or production-based business. But, if you want to stop wondering where your profits went and start quoting prices that actually make you money, understanding overhead is non-negotiable.
Whether you’re running a small fabrication shop, HVAC service business with an in-house warehouse, or a production-focused operation, this guide will walk you through everything you need to know: what manufacturing overhead is, how to calculate it, how to apply it, and what to avoid along the way.
What Is Manufacturing Overhead?
Manufacturing overhead, also called factory overhead or production overhead, includes all the indirect costs that go into making a product. These aren’t the direct labor or direct materials used on the item itself. Instead, they’re the support costs that keep production humming.
Examples of Manufacturing Overhead
- Factory rent and property taxes
- Equipment depreciation
- Utilities
- Indirect labor (maintenance, supervisors, quality control)
- Factory supplies (gloves, cleaning products)
- Equipment maintenance and repairs
- Insurance on manufacturing assets
What’s Not Manufacturing Overhead?
- Direct labor wages (technicians or machine operators working on a specific job)
- Raw materials (steel, copper piping, etc.)
- Administrative salaries (HR, accounting)
- Sales commissions
- Office utilities
If you can’t tie the cost directly to one product being built, there’s a good chance it belongs in the overhead category.
Why Manufacturing Overhead Matters
Ignoring manufacturing overhead—or underestimating it—leads to underpriced products, mystery expenses, and shaky profit margins. Worse, it clouds your view of how efficient your operations actually are.
Here’s why calculating it correctly matters:
- Accurate Pricing: You’ll know what it really costs to make a unit.
- Better Budgeting: You can forecast costs and prevent surprises.
- Smarter Decision-Making: Want to know which jobs or clients are most profitable? You’ll need accurate overhead allocation.
- Tax Deductions: Certain overhead costs are tax-deductible. Tracking them properly helps at year-end.
How to Calculate Manufacturing Overhead: Step-by-Step
Step 1: Identify All Indirect Costs
Start by gathering a list of every cost that supports production but doesn’t touch the product directly. This includes:
- Factory rent: $4,000/month
- Utilities: $1,500/month
- Maintenance staff wages: $2,500/month
- Factory insurance: $500/month
- Equipment depreciation: $1,000/month
- Indirect materials and supplies: $700/month
That’s your monthly manufacturing overhead.
Step 2: Choose a Cost Driver
A cost driver is the activity that causes overhead. This is what you’ll use to allocate your overhead to each unit or project.
Common cost drivers include:
- Direct labor hours
- Machine hours
- Units produced
Choose whichever is most logical for your operation. If your shop runs highly automated equipment, machine hours might be best. For labor-intensive services, labor hours may be the smarter route.
💡 Tip: For a quick read on how well your team is turning hours into revenue, check your labor efficiency ratio.
Step 3: Calculate the Overhead Rate
This step helps you figure out how much overhead to assign per unit, hour, or batch.
Overhead Rate Formula:
Example:
Let’s say your cost driver is direct labor hours, and your team logged 400 hours this month.
That means for every labor hour spent on a project, you should apply $25.50 in overhead to accurately reflect total costs.
Step 4: Apply Overhead to Jobs or Products
Let’s say a recent job used 10 hours of labor:
If the job also used $800 in materials and $300 in direct labor, your total job cost becomes:
That’s the true cost of doing business.
Want to gauge the overall financial health of your business? Learn how to calculate your profitability ratio.
Alternative Overhead Calculation Methods
1. Activity-Based Costing (ABC)
For businesses with varied production activities, ABC assigns costs more precisely. You track each activity (e.g., machine setup, quality testing), and apply overhead based on how much of each activity a product consumes.
- More accurate
- Time-consuming to set up
- Best for larger or complex operations
2. Predetermined Overhead Rate
Calculated in advance based on estimated costs and driver volumes.
This helps with pricing jobs before you know actual totals but requires adjustments later.
Common Mistakes to Avoid
Mistake #1: Using the Wrong Cost Driver
If your business is machine-heavy but you base overhead on labor hours, your cost allocations will be off.
Mistake #2: Ignoring Maintenance and Repairs
Equipment doesn’t fix itself. Forgetting to include maintenance expenses underestimates your real costs.
Mistake #3: Applying Overhead Inconsistently
Applying overhead to some jobs but not others skews job costing and can lead to inaccurate profit margins.
Mistake #4: Confusing Admin Costs with Overhead
Your office manager’s salary isn’t production overhead. It goes under general and administrative (G&A), not manufacturing.
Real-World Example: HVAC Service Business
Monthly Overhead Costs
- Warehouse lease: $3,000
- Utility bills: $1,200
- Shop foreman’s salary: $4,000
- Equipment depreciation: $800
- Tools and supplies: $500
Total Overhead: $9,500
If your team logs 475 labor hours per month:
A mini-split installation that takes 5 hours? Add $100 in overhead to the job’s cost.
What to Do With This Information
Once you’ve calculated your overhead rate, here’s how to put it to work:
- Set pricing that actually covers your costs
- Track margins by job or service type
- Find inefficiencies—if overhead’s rising faster than sales, it’s time to tighten operations
- Improve quotes—no more “ballpark” numbers that blow up in your face later
Take Control of Your Costs Starting Now
Don’t let your business run blind to its real costs. Start by gathering your indirect expenses this month, pick a smart cost driver, and apply your overhead to every job moving forward. You’ll be amazed how much clearer your margins become—and how much easier pricing decisions get. Want to make it even smoother? Use accounting software, like Aptora’s Total Office Manager, or cost-tracking tools that let you automate overhead calculations and keep your profit margins in check.
FAQs
1. Is manufacturing overhead the same as operating expenses?
Nope. Manufacturing overhead relates only to production. Operating expenses include office rent, marketing, and admin salaries, which don’t get tied to production.
2. What’s the difference between actual and applied overhead?
Actual overhead is what you truly spent. Applied overhead is what you estimated and allocated based on your cost driver. You may need to reconcile the two at the end of the period.
3. Can I include shipping in manufacturing overhead?
Not usually. Inbound shipping (getting materials to your plant) might count. Outbound shipping (sending products to customers) is a selling expense.
4. How often should I update my overhead rate?
At least quarterly. If your business has seasonal swings or rapid growth, monthly might make more sense.
5. Can a small field service business skip calculating overhead?
You can, but you shouldn’t. Even small businesses benefit from tracking overhead—it sharpens pricing, budgeting, and profit analysis.
