A Straightforward Guide for UK Manufacturers
Manufacturing overhead is one of those accounting terms that sounds more complicated than it actually is. But here’s the thing, if you’re not tracking your overhead costs properly, you won’t get your pricing, profitability, and making smart business decisions right.
I’ve sat down with many manufacturing business owners who know exactly what their materials cost and what they’re paying their production staff. But when I ask about their overhead costs? That’s when things get a bit fuzzy.
Let me show you exactly what manufacturing overhead is, why it matters, and how to calculate it properly for your business.
What Actually Is Manufacturing Overhead?
Manufacturing overhead (sometimes called factory overhead, production overhead, or factory burden) is every cost involved in running your production facility that isn’t direct materials or direct labour.
Product Costing Accountant – Skynet Accounting – Accountants For Manufacturing & Engineering
Think of it this way: if you can’t directly trace a cost to a specific product you’re making, it’s probably overhead.
Your raw materials, the wages of your machine operator are direct costs. But the electricity running those machines, the rent on your factory, the depreciation on your equipment, and the salary of your production manager are all overhead.
These are the costs that keep your factory doors open and your production line running, but they don’t physically become part of your finished product.
Why Should You Care About Manufacturing Overhead?
Here’s why this matters more than you might think.
First, overhead costs are usually much bigger than people realise. In some manufacturing businesses, overhead can account for 30-50% of total production costs. If you’re not tracking these properly, your pricing could be way off.
The £1m to £10m Manufacturer’s Breakthrough Plan
Second, overhead costs directly affect your profitability. You might think you’re making a healthy margin on each sale, but if you haven’t factored in your true overhead costs, you could actually be losing money on every unit.
Third, understanding your overhead helps you spot inefficiencies. When overhead costs start creeping up as a percentage of production, something needs investigating. Maybe you’ve got too much idle equipment, or perhaps your utility bills have jumped without you noticing.
Finally, you need accurate overhead figures for proper product costing, especially if you make multiple products. Different products use different amounts of your factory resources, and your costing needs to reflect that.
Breaking Down Manufacturing Overhead: What’s Included?
Let’s look at the main categories of manufacturing overhead costs you need to track.
Indirect Materials are supplies used in production that don’t become part of the finished product. This includes things like lubricating oil for machines, cleaning supplies for the factory floor, small tools, sandpaper, rags, and protective packaging. They’re necessary for production but can’t be traced to specific units.
Indirect Labour covers wages for factory staff who support production but don’t directly make products. Your production supervisors, maintenance technicians, quality control inspectors, factory cleaners, and stores personnel all fall into this category. They’re essential to keeping production running smoothly, but their time isn’t tied to specific products.
Factory Building Costs include rent or mortgage payments on your production facility, business rates, building insurance, repairs and maintenance, and security costs. If you own your building, don’t forget to include depreciation.
Electronics Manufacturing Bottleneck Operations
Utilities are the costs of keeping your factory operational. Electricity for machines and lighting, gas or oil for heating, water for production processes and facilities, and waste disposal services.
Equipment Costs cover depreciation on production machinery, equipment insurance, repairs and maintenance contracts, and calibration costs for precision equipment.
Other Production Overheads might include health and safety equipment and supplies, factory staff training, production planning costs, and inventory storage costs within the factory.
What’s NOT Manufacturing Overhead?
This trips people up sometimes, so let’s be clear about what doesn’t count as manufacturing overhead.
Sales and marketing expenses, office rent and administration costs, and delivery and distribution expenses are all operating expenses, not manufacturing overhead. Finance costs like loan interest and professional fees for accountants and solicitors are also not manufacturing overhead.
Manufacturing overhead only includes costs directly related to running your production facility.
How to Calculate Your Total Manufacturing Overhead
The basic calculation is straightforward. Add up all your overhead costs for a specific period. Usually a month or a year.
Let’s say you’re calculating for January. Your overhead costs might look like this:
- Indirect materials: £2,500
- Indirect labour (supervisors, maintenance): £8,000
- Factory rent: £4,000
- Utilities: £3,200
- Equipment depreciation: £2,800
- Insurance: £600
- Repairs and maintenance: £1,400
- Health and safety: £500
Total Manufacturing Overhead = £23,000 for January
That’s your total overhead figure but knowing the total isn’t enough. You need to allocate these costs to your products.
How to Double Revenue in CNC & Laser Cutting Industry
Calculating Manufacturing Overhead Rate
The overhead rate (also called the overhead absorption rate or burden rate) tells you how much overhead cost to add to each unit of production.
The formula is:
Overhead Rate = Total Manufacturing Overhead ÷ Allocation Base
The allocation base is whatever measure you use to spread overhead across your production. Common allocation bases include:
Direct Labour Hours – good if your products are labour-intensive and use similar amounts of overhead per labour hour.
Direct Labour Costs – works well when wage rates vary across different products or production areas.
Machine Hours – ideal for automated production where machine time is the main driver of overhead costs.
Units Produced – simplest method, but only works well if all your products are similar and use roughly the same resources.
Let’s work through an example using machine hours.
Say your January overhead was £23,000 and your machines ran for 1,150 hours total.
Overhead Rate = £23,000 ÷ 1,150 hours = £20 per machine hour
Now, if Product A takes 2 machine hours to produce, it carries £40 of overhead. If Product B takes 5 machine hours, it carries £100 of overhead. This gives you a much fairer allocation of costs.
Using Multiple Overhead Rates for Better Accuracy
As your business grows, you might want to get more sophisticated. Instead of one overhead rate for the whole factory, you could use different rates for different departments or cost centres.
For example, your machining department might have high equipment costs but low labour costs, while your assembly department is the opposite. Using separate rates for each department gives you more accurate product costs.
Machining Department Overhead Rate = Machining Overheads ÷ Machine Hours
Assembly Department Overhead Rate = Assembly Overheads ÷ Labour Hours
This is called activity-based costing, and it’s particularly useful if you make diverse products that use your facilities very differently.
Common Mistakes When Calculating Manufacturing Overhead
I’ve seen these errors many times, so watch out for them.
Missing costs entirely. Small overheads add up. That annual equipment calibration, those safety boots for staff, the factory first aid supplies, include everything.
Mixing up production and non-production costs. Keep manufacturing overhead separate from general business expenses. Your sales team’s salaries aren’t manufacturing overhead.
Using outdated figures. Overhead costs change. Energy prices go up, equipment ages and needs more maintenance, insurance premiums increase. Review your calculations regularly.
Choosing the wrong allocation base. If you pick machine hours but your overhead is mainly driven by labour, your product costs will be distorted. Choose an allocation base that reflects how products actually consume overhead resources.
Forgetting about seasonality. If your production volume varies throughout the year, your overhead rate will too. You might want to calculate a predetermined overhead rate based on expected annual activity.
Applying Overhead to Your Products
Once you’ve calculated your overhead rate, applying it is straightforward.
For each product, multiply the allocation base quantity by the overhead rate.
Using our earlier example with a £20 per machine hour rate:
- Product A uses 2 machine hours: £20 × 2 = £40 overhead
- Product B uses 5 machine hours: £20 × 5 = £100 overhead
Add this to your direct materials and direct labour, and you’ve got your total production cost per unit.
Monitoring Your Overhead Over Time
Calculating overhead once isn’t enough. You need to track it over time and look for trends.
Calculate your overhead as a percentage of production costs each month. If this percentage is climbing, investigate why. Are your overhead costs increasing? Has production volume dropped? Either way, something needs addressing.
Also track actual overhead against budgeted overhead. Big variances tell you something’s gone wrong. Maybe energy costs have spiked, or unplanned equipment repairs have consumed into your budget.
Get Your Manufacturing Overhead Under Control
Understanding and calculating manufacturing overhead isn’t just an accounting exercise. It’s fundamental to knowing your true production costs, pricing your products properly, and running a profitable manufacturing business.
Get this right, and you’ll have the information you need to make smart decisions about pricing, production efficiency, and where to invest in your business. Get it wrong, and you’re essentially guessing and guesses don’t usually lead to healthy profit margins.
If you’re struggling to get a handle on your overhead costs, or if you’re not confident your current calculations are accurate, you don’t have to figure it out alone. An accountant who understands manufacturing can help you set up proper overhead tracking and ensure your product costing reflects reality.
Want to get crystal clear on your manufacturing overhead and what it means for your profitability? Let’s talk about your business and how accurate overhead calculations can transform your decision-making.
Get in touch for a straightforward conversation about your costs.
Apply For a Call – Skynet Accounting – Accountants For Manufacturing & Engineering
Follow me on LinkedIn: www.linkedin.com/in/skynet-yesim-tilley
About the Author
Written by Yesim Tilley Founder of Skynet Accounting is a chartered accountant with over 20 years of experience supporting manufacturing and engineering businesses across the UK. Specialising in cost analysis, product costing, and financial strategy, she helps industrial businesses understand their numbers and make more profitable decisions. Skynet Accounting provides tailored finance, compliance, and taxation support designed specifically for the manufacturing and engineering sector.