How to Figure Overhead for a Small Service Business

Many people start a small service business without a clue how to figure overhead expenses. I spent time making a business plan, checking competition in the market, and doing everything the brochures from the local Chamber of Commerce said to do.

The one thing I could not find was how to figure overhead for a service business. Even the CPAs I had used could not tell me in simple terms. After searching and finding only information on overhead for a retail or manufacturing business, I stopped looking, although, I never forgot about it.

One day, while contracting in an Architectural office, I asked the man I was working with about overhead. He told me about the book, Managing, Marketing, and Budgeting for the A/E Office by George O. Head & Jan Doster Head, published by Van Nostrand Reinhold (June 1988). There the information was, in simple terms I could understand.

Knowing the Overhead Numbers

Running a service business is a tricky proposition at best. There are many ways to lose money doing service work. The only expenses that are fixed are supplies, which do not make up the majority of the expense budget. Everything else is subject to change, usually on a daily basis. With labor expenses consuming most of the budget (usually from 60% to 80%), knowing how much to charge per job or per hour is essential! This simple formula helped me operate that small service business for 17 years.

Formula for Business Overhead Expenses

Overhead Percent Formula:

Total Expenses $__________________

Less Reimbursable Expenses $__________________

Equals Adjusted Expenses $__________________

Less Gross Salaries $__________________

Equals Overhead Expense $__________________

OH Expense divided by Gross Salaries = ______OH %

Unbillable Time Percent Formula:

Total Hours Paid $_________________

Less Hours Billed $_________________

Equals Unbillable Hours $_________________

Unbillable Hours divided by Hours Paid = ___________% Unbillable Time

Individual Employee Hourly Cost:

(Name) Gross Hr. Rate $____ + $_____ (___) %OH + $____ (___) % Unbill. Avg. Time = $_____ per Hr.

(Include all employees here, even executive)

The total of "Per Hour" for all employees, divided by number of employees will equal the hourly rate. This number will be the "break even" point. Add any percentage of profit deemed reasonable. Averaging these numbers monthly, dropping the oldest number and adding the new number, will give an average for the year. These numbers can be easily set up on a spreadsheet.

This formula is understandable, very workable, and accurate. For other examples of overhead formulas, see the Ohio State University Fact Sheet, Community Development, "Pricing", Small Business Series by Gregory R. Passewitz. This publication gives numerous examples for figuring overhead costs.

Whatever method a small service business owner chooses, this information is necessary to maintain adequate pricing. Knowing what the business overhead numbers are is essential for longevity, and profitability.