Overhead Ratio Formula

Overhead Ratio Formula (Table of Contents)

• Overhead Ratio Formula
• Overhead Ratio Formula Calculator
• Overhead Ratio Formula in Excel (With Excel Template)

Overhead Ratio Formula

Overhead Ratio can be defined as the ratio of the operating expenses and summation of operating income and taxable net interest income. It can also be defined as the comparison of any firm’s operating expenses to total income that is not attributable to the firm’s goods and services.

Here’s the overhead ratio formula –

Example of Overhead Ratio Formula

Let’s take an example to find out the overhead ratio for a company: –

The total revenue for a company is Rs 100000. The costs of goods sold are Rs 25000. The selling, general and administrative expenses including depreciation is Rs 25000. The net interest income is Rs 10000.

Then the overhead ratio can be calculated below: –

Operating Income = Revenue – Cost of goods sold – Selling, General  & Administrative expenses – Depreciation

• Operating Income = Rs 100000 – Rs 25000 – Rs 25000
• Operating Income= Rs 50000

Operating Expenses = Salary, General & Administrative Expenses including Depreciation

• Operating Expenses = Rs 25000
• Net Interest Income = Rs 10000

Hence, Overhead Ratio using formula can be calculated as: –

Overhead Ratio = Operating Expenses / (Operating Income + Net Interest Income)

• Overhead Ratio = 25000 / (50000 + 10000)
• Overhead Ratio = 25000 / 60000
• Overhead Ratio = 41.67%

Explanation of Overhead Ratio Formula

The overhead ratio is a financial ratio that lets the firm know what their expenses are as a percentage of their income.  The operating expenses are the expenses incurred daily by any firm which includes sub-items such as rent, utilities, maintenance, salaries and wages, depreciation on plant and machinery etc. Net Interest Income is the difference between interest earned over a financial period and interest paid on debt for the same financial period. Operating income is the firm’s income from manufacturing of goods and services after deducting all the expenses.

The common overhead items are costs that are not directly related to the manufacturing of good and service which are direct labor, direct raw materials, and expenses billed directly to the customer. The items that can be considered as overhead costs are selling, general and administrative expenses such as rent, utilities, salaries and wages, maintenance expenses etc. One can find these sub-items on the income statement which represent the difference between gross and operating profit. Overhead costs can either be fixed, semi-variable or variable costs but these are indirect costs.

Significance and Use of Overhead Ratio Formula

Any firm would strive to lower this ratio without affecting their product quality or competitiveness in the industry. A firm can cut their expenses to have a positive effect on the overhead ratio but it can affect the quality of the goods and services that it provides.

One can look at gross profit margin and operating margin to understand how overhead costs are affecting the income statement of an economy. Gross profit margin includes the costs associated directly with manufacturing a good or the service provided by the company while operating margin includes both direct and indirect costs associated with producing that good or service.

Overhead ratio alone does not indicate anything about the firm’s operations. It should be compared to the other competitors and close to the industry standard. For example: – for the above firm the overhead ratio is 0.41. If the industry standard is 0.3 it indicates that the firm’s overhead costs are more than the industry standards and the indirect costs are bloated in comparison to direct costs hence the firm needs to reduce these overhead costs so as to maximize profit.

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However, similarly it does not mean that firms should reduce their overall overhead costs to a minimum. Reducing it will affect the company’s performance in terms of quality and affect the company negatively. The firm should try to maintain a balance of the ratio in terms of industry standards and also it should not affect the efficiency of the company.

Overhead Ratio Calculator

You can use the following Overhead Ratio Calculator

Overhead Ratio Formula in Excel (With Excel Template)

Here we will do the same example of the Overhead Ratio formula in Excel. It is very easy and simple. You need to provide the three inputs of Operating Expenses, Operating Income, and Taxable Net Interest Income.

You can easily calculate the Overhead ratio using Formula in the template provided.

First, we need to calculate Operating Income

Then we need to find out Operating Expenses.

Now, we can calculate Overhead Ratio using Formula

You can download this Overhead ratio Template here –  Overhead ratio Formula Excel Template

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