Overhead BudgetExplained & Defined

Written By:
Adiste Mae

Reviewed By:
FundsNet Staff

Overhead Budget Meaning

Overhead Budgeting is a budgeting technique used primarily by manufacturing companies.

It is used to forecast the overhead budget.

The Overhead Budget covers costs that the company is expected to incur in the next accounting year but will not include the direct materials and direct labor costs.

Components of Manufacturing Overhead Budget

The different components of the Manufacturing Overhead Budget are the following:

Employee Costs

These are the salaries and wages of company employees.

The company includes this type of cost whenever they do budget forecasting because employees contribute significantly to producing the company’s products for sale.

Insurance Expense

There are types of expenses that are insurance-related contracts like building and employee insurance which is regularly paid through premium expenses.

Since it is part of the business operations and is regularly incurred, the management includes them in the next accounting year’s overhead budget.

Rent Expense

These are real properties that are rented regularly by companies.

For example, the production facility, warehouse facility, or even delivery vehicles, service vehicles, machinery, etc.

Since they play a significant role in a business’s operation, it is best to include them in the overhead budget.

Depreciation

The nature of fixed assets is their value deteriorates over time.

This means, its value decreases every period, and the proper accounting for its current value is through depreciation.

It also means that at the end of the accounting period, the assets must be recorded at their book value (original costs minus accumulated depreciation).

Freight

It is the expense paid for transporting goods from one place to another.

Companies regularly order raw materials from their suppliers, so the freight costs from deliveries are to be included in the Overhead Budget.

Utility Expense

There are services provided by public utility companies like electricity, water, telecommunications, etc.

Every service subscription corresponds to relative payments accounted for as utility expenses.

These are essential company costs that need to include in the overhead budget.

Maintenance Cost

Since a company’s fixed assets deteriorate, one of the best methods to preserve such assets is through maintenance.

The frequency of asset maintenance must be regular.

Therefore it is also an expected cost for the company in the following accounting year.

Taxes

Taxation is the lifeblood every of every government to be able to perform its duties and responsibilities across the nation.

These tax obligations are inevitable for business enterprises or all income-earning individuals.

The compulsory tax payments will be based on which category a taxpayer belongs.

Taxes paid are accounted for as tax expenses.

There can also be other possible costs a company may include in its overhead budget, as long as it’s related to business operations.

Example of Manufacturing Overhead Budget

M&G Enterprise is a paper manufacturing company.

The company is preparing an overhead budget forecast for the year ended 2022.

The relative information is as follows:

• Employee Costs
  • Qtr 1 – $22,000
  • Qtr 2 – $27,300
  • Qtr 3 – $32,800
  • Qtr 4 – $35,000

• Utility Expense
  • Qtr 1 – $5,200
  • Qtr 2 – $6,600
  • Qtr 3 – $7,100
  • Qtr 4 – $7,500
• Income Tax Expenses
  • Qtr 1 – $3,200
  • Qtr 2 – $3,600
  • Qtr 3 – $4,100
  • Qtr 4 – $4,500

Fixed for all 4 Quarters:

• Insurance Expense – $5,000
• Rent Expense – $10,000
• Depreciation Expense – $7,500

The total overhead expenses will then be budgeted as follows:

Overhead Budget for M&G Enterprise for the Year Ended 2022

Advantages & Disadvantages

Advantages

With an Overhead Budget, companies can adequately plan all the related production and non-production expenses.

Its advantages include the following:

• There is a set threshold of expenses thereby guiding the management to avoid overspending and incurring unnecessary expenses.
• It guides the management on where best to allocate the company’s budget to achieve the company’s goal and to put more focus on costs that will create a positive impact on the company.

Disadvantages

• Budgeting requires the best knowledge and understanding of the company’s operations and familiarity with systems and processes put in place. Because of this, budgeting requires a lot of time and effort to reasonably estimate the expenses of the company.
• Budgeting relies on management/experts’ best estimates. An accurate budget plan may be difficult to achieve due to the constantly changing market conditions which could affect prices, supply chain, etc.

Important Points

Some vital points regarding Overhead Budget are:

• Companies that have been in the business for quite some time can have a very effective overhead budget by following historical transactions and trends. And sometimes, the forecasted budget is close to accurate. But start-up businesses or any company new to the business still rely on different budget forecasting techniques.
• Overhead budgets are the so-called overhead expenses incurred by the company in the accounting period it applies. Through budgeting, the management and its employees are better guided when it comes to expenditure limits and work towards the goals of the company.
• Preparing a budget for smaller companies may prove to be inconvenient as fewer data are available.

Conclusion

The overhead budget is also the company’s overhead expenses in the following accounting year.

Budgeting can be used as a monitoring and control tool which the management and employees can refer to as a guide to avoiding overspending and keeping in line with the company’s goals as a whole to achieve the needed results.