Overhead Costs: A Complete Guide for Service Businesses

What are overhead costs in a service business? 

Overhead costs are made up of the necessary ongoing expenses and administrative costs that keep your business up and running. In a service business, common overhead costs include: 

• Office rent payments
• Property tax
• Utilities, like heat, water, and electricity
• Cell phone bills, website hosting, and internet
• Office supplies (administrative overhead)
• Office cleaning or janitorial services
• Licenses and permits
• Legal expenses
• Insurance payments
• Company vehicle maintenance
• Accounting or reception staff wages
• Marketing costs, like a lead generation platform 
• Home service software

Direct cost for specific jobs, such as materials and labor cost, are not considered overhead. Those are calculated individually for each job and are included in the invoice you send to a customer. They usually fall under operating costs or operating expenses. 

On the other hand, equipment repairs count as overhead costs because you need them to run your business.

What are the different types of overhead?

There are three types of overhead costs: fixed, variable, and semi-variable.

• Fixed overhead is made up of consistent costs that aren’t expected to change regardless of how busy you are, like rent or insurance payments. 
• Variable overhead includes costs that can fluctuate month-to-month, like marketing expenses. Variable costs can change based on your business activity and may increase during busy seasons and decrease during off-seasons.
• Semi variable overhead costs are expenses that are always there, but that may change slightly from month to month, like your electricity bill. For example, you may pay a base rate for electricity and then an additional amount per kilowatt depending on your usage.

How does overhead affect profit?

Overhead plays a major role in the profitability of your business. If you don’t account for business metrics like overhead costs when setting and adjusting service prices, you could end up making little to no money on completed jobs.

When setting prices, the amount you charge for a service needs to: 

• Cover job-specific costs like materials and labor
• Contribute to overhead costs like office rent and utilities
• Include a healthy profit margin

The only way you can ensure you make a profit is to calculate and include overhead costs in your pricing. If you only account for job-specific costs in your invoices, you won’t have any money left to cover your overhead expenses, let alone make a profit.

How do I calculate overhead?

When it comes to calculating your overhead, you have two options. You can calculate a percentage to add to the cost of each job, or you can calculate an amount to add to your hourly rate. 

But before you do either, you need to add up all of your monthly overhead costs. Try to choose an average month where your expenses are predictable and consistent. 

Then, calculate all the money you made from jobs in the same month. 

For these examples, let’s say your total monthly overhead cost is  $10,000 while your sales are $40,000.

Calculating overhead costs as a percentage

To calculate your overhead rate as a percentage, use this formula: 

Overhead percentage = total overhead costs / total sales x 100

First, take your monthly total overhead cost and divide it by your monthly sales. 

Then multiply it by 100.   

10,000 / 40,000 = 0.25

0.25 x 100 = 25%

In this example, the overhead rate is 25%, meaning that 25% of your total sales amount goes towards overhead costs. So, you would need to charge an additional 25% on top of materials and labor for a job to cover overhead expenses.

Calculating overhead costs as an hourly rate

To calculate your hourly overhead rate, you’ll need to add up the total billable hours for the month on top of your overhead expenses and sales. 

So, if you have five full-time employees working 40 hours per week, your billable hours for the month would be 800 (160 hours per employee). 

The formula to calculate your hourly overhead rate is as follows: 

Overhead rate per hour = total overhead costs / total billable hours

Using the numbers from our examples, an hourly overhead rate would be: 

$10,000 / 800 = $12.50

That means that you would add $12.50 an hour to the hourly rate you charge for a job before overhead costs. 

How does a profit margin factor in?

The numbers you calculate to cover overhead only represent how much you need to charge to break even. You will still need to include a profit margin to ensure you make money. 

FREE TOOL:Profit margin calculator

Because your fixed overhead costs tend to increase year-over-year, it’s important to track expenses and review them on a regular basis to ensure they’re not eating away at your profit. 

If this happens, you may need to increase your prices to reflect growing costs. 

READ MORE: Profit margins: A complete guide for small business owners

How much overhead should I have?

Generally, an overhead rate of 35% or below is considered healthy for most businesses. However, it varies between industries, services, location, and other factors, like the size of your business. 

For example, in major cities, overhead costs may be more due to higher wages, rent prices, and utilities. In suburbs or more rural areas, costs may be lower. 

One way to determine whether your overhead is healthy or not is to take a look at your competitors’ expenses. Although you won’t be able to tell exactly what they’re spending or making each month, review where they rent office space, what kind of advertisements they run, and what their equipment looks like.

This will give you a feel for what they’re spending to maintain their business, at least from a high-level perspective.

You can also talk to other service business owners in your industry at networking events or in online forums like the Jobber Entrepreneurship Group to get advice and information from real people.

How can I reduce overhead?

After calculating your overhead costs, you may be surprised by how much they add up to each month. From cell phone bills and utility costs to office rent and supplies, it takes a lot to run a service business. 

If you want to increase your profit without upping your prices, cutting down on overhead is a great way to do it. Use these tips to get started. 

1. Reduce your bills

Phone, internet, and software bills all make up a chunk of your overhead costs. You can try to reduce them by negotiating with service providers or even cutting out plans that you’re no longer using.

For example, if you’re paying for monthly marketing software, but you only use it once a year, it may be time to look for a cheaper alternative or cancel the service altogether.

Another option is to look for software that offers more for less. Instead of paying separately for scheduling software, invoicing software, and a CRM, find a solution that offers it all in one, like Jobber.

READ MORE: Find out how this pest control company cut their software bill in half

The same goes for your internet and phone bills. Look for corporate rates, and simpler service plans, and cancel any services or add-ons that aren’t necessary to run your business.

And, if your business requires supplies, find out whether buying materials in bulk will save you money in the long run, even if it costs more upfront.

2. Downsize your office space

As a home service business, you do most of your work in your clients’ homes or at job sites. This means that you probably don’t need a big, fancy office to file paperwork in. 

If possible, move your office to a smaller space or even opt to have office employees like dispatchers work remotely. This can save you a huge amount of money on overhead.

If you can’t downsize, consider negotiating rent costs with your landlord.

3. Hire contractors or part-time workers

Accounting, reception, and janitorial staff all count towards your overhead. But you may not need them to all work full-time. When possible, hire subcontractors or part-time workers for overhead-related roles to save on costs.

You can always bring on full-time staff down the road when your business is able to support them.

4. Use business software wherever you can

From bookkeeping and accounting to client management and marketing, there are software platforms for just about everything you need to run your business. 

Instead of hiring staff members to oversee booking appointments, facilitating payments, and sending invoices, use software to do it instead. 

Monthly software subscriptions are often significantly cheaper than part- or full-time staff members and can take care of a variety of tasks. 

And, if you don’t have time to manage the software yourself, you can always hire someone to do it for you. Having one part-time administrative employee or contractor will probably still be more cost-effective than bringing on multiple staff members.

5. Go paperless

Printing and mailing contracts, quotes, invoices, and receipts costs more than you think. Ink, paper, stamp, printer, and envelope costs all add up over time. Not to mention the stress of losing any of those documents.

By going paperless and sending communications through email or text, you can save money, and time, and keep track of an organized paper trail.

Plus, clients will appreciate how easy it is to work with you when they can approve contracts and pay online. Here’s what quote approvals look like in Jobber: