Overhead Ratio Formula

Overhead ratio is the ratio of operating expenses to the operating income; giving details about the percentage of fixed costs involved in generating a specific operating income for a company; a lower overhead ratio means that the higher proportion of expenses are related to direct product costs, implying that the company has minimized expenses that are not directly related to production.

Overhead Ratio Formula (Table of Contents)

• Overhead Ratio Formula
• Overhead Ratio Calculator
• Overhead Template

Overhead Ratio Formula

The overhead formula is specifically useful for banks. Here we take the operating expenses into account and compare the expenses with the total income that can’t be attributed directly to the production of goods and services.

Here’s the overhead ratio formula –

Alternatively, many argue that overhead can be expressed as the proportion between operating expenses and the revenue; however, this proportion is called the operating expense ratio, not an overhead ratio.

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Overhead Ratio Example

Let’s take a simple example to calculate overheads.

HoHey Restaurant has the following information –

• Operating Expenses – $23,000
• Operating Income – $115,000
• Taxable Net Interest Income – $46,000

Find out this ratio of HoHey Restaurant.

We know both the numerator and the denominator of this ratio.

• Operating expenses are $23,000.

The denominator would be the sum of operating income and taxable net interest income.

Using the overhead formula, we get –

• Overhead Formula = Operating Expenses / (Operating Income + Taxable Net Interest Income)
• = $23,000 / ($115,000 + $46,000)
• = $23,000 / $161,000 = 14.29%.

To interpret this ratio of HoHey Restaurant, we need to look at the ratios of other restaurants serving the similar food and providing the similar services.

Explanation of Overhead Formula

In this ratio, we have to consider two components.

The first component is the operating expenses. Operating expenses are the day to day expenses that the company needs to run the business. For example, utilities, machinery maintenance, office rent, professional fees, insurance etc. are operating expenses.

The second component of overhead Ratio is a tricky one.

• We will take the operating income and also the taxable net interest income.
• When we deduct the operating expenses from gross profit, we get the operating income.
• To get the net interest income, we need to look at the difference between how much a company receives interest and how much it pays off.
• Net interest income is a common measure for banks. But we can calculate the same for companies also.
• We will add the operating income and the taxable net interest income to get the denominator.

Use of Overhead Formula

Overhead Formula is a significant measure for any company; because if it is lower, better would be the performance of the company. On the other hand, if it is higher, the company isn’t utilizing its resource prudently.

Every company should try to lower the ratio as much as it can.

There are two portions of the operating expenses that a company can look at.

• The first component of the operating expenses is expenses that can’t be curbed at all. In this case, the company should try to reduce this component as much as they can.
• The second component of the operating expenses can be removed completely. The company should take steps to pare down this second component to reduce this ratio.

However, reducing the ratio shouldn’t affect the company’s performance. Too much reduction in operating expenses may affect the company negatively. The company should try to maintain a balance and reduce only that much which doesn’t reduce the efficiency of the company.

Overhead Ratio Calculator

You can use the following Overhead Ratio Calculator

Overhead Ratio Formula in Excel (with excel template)

Let us now do the same example above in Excel. This is very simple. You need to provide the three inputs of Operating Expenses, Operating Income, and Taxable Net Interest Income.

You can easily calculate the ratio in the template provided.

Overhead Ratio Formula Video

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This has been a guide to Overhead Ratio formula, its uses along with practical examples. Here we also provide you with Overhead Ratio Calculator with downloadable excel template. Learn more from the below articles –

• Calculation of Book Value Formula
• Calculating the Ratio in Excel Formula
• What is Interest Income?
• Financial Ratios in Excel
• Private vs Public Sector Banks
• Bank Balance Sheet vs Company Balance Sheet
• Price to Book Value Formula