What it is:
Overhead refers to the ongoing operating expenses necessary to running a business, but are not attributed to a specific business activity. Also referred to as "indirect costs."
How it works (Example):
Generally, overhead expenses include expenses that do not directly generate revenues, such as labor and materials, but are needed to maintain the business operations. Overhead expenses include expenses such as accounting, advertising, depreciation, insurance, interest, legal, rent, repairs, office supplies, taxes, information and communications, utilities, research and development, customer relations and service, and travel. These overhead expenses are listed on the company's income statement.
Why it Matters:
Overhead costs are considered fixed costs, that is, they do not rise or fall directly with the cost of goods sold. Overhead costs are important to monitor and control. Since they are not directly related to revenues, they can become a larger share of the total expenses and burden a company, soaking up net income and profits.