What is Overhead Rate?
The overhead rate is a financial ratio that measures the proportion of a company’s revenue that is allocated to overhead costs. Overhead costs are the indirect expenses that a company incurs in its day-to-day operations, such as rent, utilities, insurance, marketing, and administrative costs. These costs are not directly related to the production or delivery of goods and services, but they are necessary to support the core operations of the business.
The overhead rate can be used to evaluate the efficiency and profitability of a company, as well as to compare it with other companies in the same industry. A lower overhead rate means that a company is spending less on overhead costs relative to its revenue, which implies that it has more resources available for investing in growth, innovation, or improving product quality. A higher overhead rate means that a company is spending more on overhead costs relative to its revenue, which implies that it has less resources available for other purposes, and that it may face challenges in maintaining its competitive edge.
How to Calculate Overhead Rate in Excel?
There are different ways to calculate the overhead rate, depending on the allocation measure that is used. The most common method is to use revenue as the allocation measure, which means that the overhead rate is calculated by dividing the total overhead costs by the total revenue in a given period. However, other measures can also be used, such as direct costs, machine hours, or labor hours, depending on the nature and structure of the business.
To calculate the overhead rate in Excel, we need to follow these steps:
- Identify the overhead costs and the allocation measure for the period. For example, if we want to calculate the overhead rate for the year 2023, we need to find the total overhead costs and the total revenue (or other measure) for that year.
- Enter the overhead costs and the allocation measure in separate cells in Excel. For example, we can enter the overhead costs in cell B2 and the revenue in cell B3.
- Enter the formula for the overhead rate in another cell. For example, we can enter the formula
=B2/B3in cell B4. This will divide the overhead costs by the revenue and return the overhead rate as a decimal number. - Format the cell with the overhead rate as a percentage. To do this, we can select the cell and click on the Percentage button in the Number group on the Home tab. This will multiply the decimal number by 100 and add a percentage sign. Alternatively, we can use the shortcut Ctrl+Shift+%.
Example of Overhead Rate Calculation in Excel
Let’s say we want to calculate the overhead rate for a company that has the following data for the year 2023:
- Revenue: $500,000
- Overhead costs: $200,000
We can enter these data in Excel as shown below:
| A | B | |
|---|---|---|
| 1 | Revenue | $500,000 |
| 2 | Overhead costs | $200,000 |
| 3 | Overhead rate | =B2/B3 |
Then, we can format the cell B3 as a percentage, and we will get the following result:
| A | B | |
|---|---|---|
| 1 | Revenue | $500,000 |
| 2 | Overhead costs | $200,000 |
| 3 | Overhead rate | 40% |
This means that the company spends 40% of its revenue on overhead costs, which is a relatively high overhead rate.
Other Approaches
As mentioned earlier, there are other approaches to calculate the overhead rate in Excel, depending on the allocation measure that is used. For example, if we want to use direct costs as the allocation measure, we need to find the total direct costs for the period, and then divide the overhead costs by the direct costs. Direct costs are the costs that can be directly traced to the production or delivery of goods and services, such as raw materials, direct labor, and direct expenses.
Similarly, if we want to use machine hours or labor hours as the allocation measure, we need to find the total machine hours or labor hours for the period, and then divide the overhead costs by the machine hours or labor hours. Machine hours are the hours that the machines are used for production, and labor hours are the hours that the workers are employed for production.
The choice of the allocation measure depends on the type and complexity of the business, and the level of detail that is required for the analysis. The advantage of using revenue as the allocation measure is that it is simple and easy to obtain, and it allows for a quick comparison with other companies. The disadvantage is that it may not reflect the actual relationship between overhead costs and the activities that generate revenue, especially if the company has multiple products or services with different cost structures and profit margins.
The advantage of using other measures, such as direct costs, machine hours, or labor hours, is that they may provide a more accurate and realistic representation of the overhead costs, and they may allow for a more detailed and nuanced analysis of the cost drivers and the efficiency of the production process. The disadvantage is that they may be more difficult and time-consuming to obtain, and they may require more assumptions and adjustments to account for the variations and complexities of the business.
The overhead rate is a useful financial ratio that measures the proportion of a company’s revenue that is allocated to overhead costs. It can be used to evaluate the efficiency and profitability of a company, as well as to compare it with other companies in the same industry. To calculate the overhead rate in Excel, we need to identify the overhead costs and the allocation measure for the period, and then divide the overhead costs by the allocation measure. The allocation measure can be revenue, direct costs, machine hours, or labor hours, depending on the nature and structure of the business. The overhead rate can be formatted as a percentage in Excel by using the Percentage button or the shortcut Ctrl+Shift+%.
