Overhead Costs: How to Calculate and Reduce Your Expenses

Growing companies naturally take on more costs as they expand — and not just direct production investments. A general contractor in the U.S. expanding operations to Mexico, for example, may need to rent a new office and acquire business insurance.

These indirect expenses are called overhead costs. While they don’t directly contribute to production, they’re a necessary part of doing business and can quickly eat into profitability if they aren’t properly managed.

When companies expand into multiple countries, they encounter new overhead costs. They’re now dealing with unfamiliar legal and administrative requirements that add indirect costs they didn’t have before.

Explore what overhead is, the specific expenses linked to global expansion, and how you can calculate and reduce these expenses at scale.

What are overhead costs?

Overhead costs are ongoing business expenses that can’t be directly attributed to a specific good or service a business offers. Unlike direct costs, which businesses incur to directly produce revenue, overhead costs keep the business running.

Without clear cost management, overhead costs can compound, leading to cash flow strain and budgeting issues.

Here’s why monitoring your overhead costs is important:

• Boosts profitability. Reducing unnecessary overhead expenses can directly increase your profit margins without changing your front-facing business offerings.
• Supports informed budgeting. You can use cost tracking to ensure stronger forecasts and allocate your resources more effectively.
• Highlights inefficiencies. Routine reviews help you figure out where you’re leaking revenue and eliminate redundant costs.
• Helps you scale successfully. Smart overhead structures allow you to scale your business without unnecessary costs compounding.

Overhead costs vs. direct costs

An overhead cost is indirect and isn’t tied to a product, service, or customer, while a direct cost is an expense that’s explicitly incurred to generate revenue.

For example, say a business owner runs a local bakery. The flour and butter they buy to make their menu items are considered direct costs. They also need to pay any kitchen and shop staff, purchase equipment such as ovens and mixers, and invest in branded packaging. These costs are directly related to making their signature sweets, which are their core revenue drivers.

But they also need to pay monthly rent for their storefront, purchase business insurance, and buy payroll software to manage compensation for workers. These are all overhead expenses, as they contribute to the overall running of the bakery but don’t directly impact production.

Types of overhead costs

Overhead costs can fall into three categories: fixed, variable, and semi-variable. Fixed costs are fairly consistent regardless of business activities (e.g., rent, insurance, property taxes). That distinguishes them from variable costs, which shift up or down depending on business activities (commissions, materials and supplies, processing fees, for instance).

Semi-variable costs are a cross between the two. They’re costs that have both fluctuating and consistent elements. For example, this could mean salaries (fixed) plus overtime or bonuses (variable) or equipment maintenance (fixed) plus repairs (variable).

How to calculate overhead costs

The most effective way to accurately monitor indirect costs is to calculate the overhead rate using the following formula:

Total Indirect Costs ÷ Allocation Base x 100 = Overhead Rate

An allocation base is a metric for the distribution of overhead costs across departments. To choose your allocation base, select a unit that drives or corresponds to indirect costs. Common examples include total direct labor hours, machine hours, or total revenue.

Say your allocation base represents total direct labor costs from the previous year. Your total annual overhead costs add up to $120,000, while your direct labor costs stand at $300,000. Simply input these numbers into the formula to calculate the percentage:

120,000 ÷ 300,000 = 0.40 x 100 = 40%

In this scenario, for every dollar spent on direct labor, you spend an additional $0.40 on overhead. Finance teams can use this information to understand the proportion of spending that goes to overhead compared to direct production.

Common examples of overhead costs

Companies often incur overhead costs in every department. Individual account entries may vary depending on the industry, location, and operational complexity of a business, but common overhead cost examples include:

• Rent and facilities. Office leases, building maintenance, property taxes, and other facility-related expenses often comprise a sizable portion of overhead costs.
• Utilities. Utility costs like electricity, water, internet, and heating and cooling are examples of overhead expenses.
• Business insurance. This may include coverage for liability, property damage, workers’ compensation, and other operational risks.
• Administrative headcount. The salaries and benefits you pay to workers in support roles (not direct production) are considered indirect labor costs.
• Software and technology subscriptions. Any fees you pay to maintain collaboration tools, payroll software, or management systems count as overhead.
• Professional services retainers. This refers to recurring payments to third-party organizations providing administrative services, such as consultants or HR outsourcing teams.

While every organization has indirect expenses to consider, businesses that expand to operate in multiple countries often run into hidden overhead costs.

How international expansion adds additional overhead costs

On top of the standard overhead costs, global companies also add new categories of overhead, including:

• Entity setup and maintenance. Setting up a global entity comes with significant hidden costs. For example, some countries have requirements to set up a physically registered office to establish a business there.
• Country-specific legal counsel. Companies often need professional legal counsel across jurisdictions to assist with employment contracts and disputes, since business and employment laws differ by country.
• Employment compliance management. Managing international payroll costs and complying with employer obligations can complicate overhead expenses, since countries have unique employment laws. For example, accidentally misclassifying an employee can result in fines.
• Local registration and reporting requirements. Many countries, such as Canada and Germany, require organizations to register and/or obtain permits with several agencies, such as trade and tax authorities. These registrations and permits typically come with their own reporting schedules and documentation requirements, which add to overhead.
• Ongoing regulatory monitoring. Employment laws frequently change across jurisdictions. Companies usually need to rely on HR teams and compliance platforms to keep track of evolving regulations so they can adjust their processes accordingly.

Total overhead and employee costs vary across countries due to differences in fees and regulatory structures. For example, Luxembourg has some of the highest hourly labor costs of countries in the EU, which can mean high overhead for countries that hire talent for support roles there.

On the other hand, operating in Bulgaria has a corporate tax rate of just 10% and relatively cheap labor costs, which can contribute to lower overhead.

How to reduce overhead costs without slowing growth

For growth-focused companies, managing overhead is about allocating funds efficiently while scaling.

Automate administrative processes

Where possible, automating core tasks can help reduce the burden of administrative work. For example, payroll processing software can reduce the manual work required to manage payroll. Compliance tracking platforms can also monitor country-specific regulatory changes, so you don’t need to spend money on separate legal teams in each jurisdiction.

Consolidate vendors and systems

Instead of investing in multiple separate tools and software systems, opt for solutions that handle several needs at once. Using one platform for payroll processing and another for HR management can mean higher monthly subscription fees and additional costs to train employees on their functionality.

Improve workforce planning

Optimize your workforce by aligning workforce planning with your business needs and cost goals. If you want to increase production rates, then focus on hiring specialized engineers and investing in cross-training programs rather than just taking on as many new employees as you can afford (which would require additional overhead for payroll administration and bulk recruiting). This can help you reduce overhead resulting from excess overtime or costly recruiting efforts.

Use an employer of record for international hiring

When you expand to a new country, opting for an employer of record (EOR) versus establishing an entity can significantly reduce your overhead, both during initial registration and in the long term. As businesses scale, an EOR handles areas such as payroll administration and tax compliance. The lower cost of an EOR reduces your workforce burden.

Reduce global expansion overhead with Pebl

Building and managing a compliant employment infrastructure is an overhead expense for businesses expanding internationally.

Many companies begin with a plan to simply hire a few international employees, but encounter a more complex process. From registering an entity to administering country-specific payroll, a number of fixed overhead costs can hurt a business’s ability to scale.

Pebl can act as an EOR, so you don’t have to build your business from the ground up in a new country. You can hire employees across more than 185 countries without having to establish local entities, making your ongoing operations simpler and more cost-effective.

If you’re looking to scale your international operations, Pebl’s Global Payroll feature can reduce both your administrative overhead and compliance risk.

Contact Pebl today to schedule a meeting.

FAQ

How often should businesses review overhead costs?

Businesses often formally review their overhead costs at least quarterly. But many high-growth companies benefit from monthly monitoring to track scalability more accurately.

How do remote and distributed teams impact overhead costs?

While remote teams can minimize overhead for rent and utilities, they can also increase certain indirect costs associated with cybersecurity, remote collaboration tools, and, when applicable, global payroll processing.

What is the difference between overhead costs and operating expenses?

While they overlap, there are distinct differences between overhead versus operating expenses. Overhead refers to the indirect costs that support day-to-day business operations but aren't directly attributable to a specific product or service. Operating expenses fall into a broader category that covers both direct and indirect costs, including all the day-to-day expenses required to keep the business running.