Manufacturing overhead is the catchall phrase for the costs associated with operating a manufacturing facility outside of tangible product fabrication—expenses such as rent, equipment depreciation, and utilities. These indirect costs nevertheless directly influence pricing decisions, forecasts, budgets, and profitability analyses. The ability to understand, calculate, and manage these costs becomes increasingly important as manufacturing technologies advance and operational complexities grow.

What Is Manufacturing Overhead?

Overhead refers to the many costs associated with manufacturing that cannot be directly traced to specific products the way raw materials, for example, can be. Manufacturing overhead is also known as factory overhead or production overhead.

Key Takeaways

  • Manufacturing overhead includes all indirect production expenses not explicitly tied to specific products.
  • These costs include equipment depreciation, rent, and insurance premiums.
  • Accurate calculation and allocation of manufacturing overhead is essential for determining true production costs.
  • Preventive maintenance and energy-efficiency initiatives are two paths to reducing overhead costs.

Manufacturing Overhead Explained

In cost accounting, manufacturers track three main categories of expenses: direct materials, direct labor, and overhead. The first two are tied to product creation; manufacturing overhead covers everything else needed to keep the factory running efficiently and safely.

Consider a furniture manufacturer. The wood and upholstery (direct materials) and the craftsperson’s time (labor) are direct costs. However, the electricity powering the tools, the managers overseeing production, and the depreciation on the manufacturing equipment are all overhead costs—necessary for production but not directly tied to the making of any single product.

Manufacturing overhead costs can be further classified as fixed, variable, and semi-variable.

  • Fixed manufacturing costs:

    Fixed manufacturing costs remain constant regardless of product output levels; they represent long-term commitments that companies must meet whether they produce at full capacity or shut down temporarily. Fixed costs include monthly mortgage, rent, or lease payments; property taxes; insurance premiums; salaries for managers and supervisors; and equipment depreciation. Fixed costs might change over time due to annual contract renewals or market conditions, for example. Otherwise, they remain stable within normal operating periods, allowing for predictable budgeting and cost allocation.

  • Variable manufacturing costs:

    Variable manufacturing costs fluctuate with the output levels desired. Electricity and fuel costs, for example, will increase or decrease relative to equipment use. The amount of indirect materials used and overtime hours for support staff will reflect the day’s workload. Variable overhead costs are particularly important for accurate production planning and efficiency analysis. Unlike fixed costs, they can be easier to control since process improvements can bring down costs. However, this flexibility can also make forecasting challenging if the proper analysis of historical data and current market conditions are lacking.

  • Semi-variable manufacturing costs:

    As the name implies, semi-variable costs combine elements of both fixed and variable overhead expenses. They typically involve a set base cost, plus variable charges tied to usage or production volume. Such is the case, for example, with machinery maintenance, which includes a flat fee for a specific number of inspections and preventive maintenance, regardless of machine use, plus variable costs for repairs and replacement parts, which tend to increase with machine operating hours. Understanding the threshold points at which semi-variable costs shift from primarily fixed to more variable is important for predicting and managing costs.

Examples of Manufacturing Overhead

Make no mistake: Manufacturing overhead costs can add up, accounting for 8% to 12% of total operational costs and between 30% and 35% of total workforce capacity, according to McKinsey. Here is a quick list of types of overhead expenses, to be detailed in an upcoming section.

  • Rents, leases, and mortgages
  • Depreciation on equipment and buildings
  • Indirect labor costs
  • Factory supplies
  • Maintenance and repair costs
  • Utilities
  • Property taxes and insurance
  • Regulatory costs

Why Is Manufacturing Overhead Important?

Just as a theatrical production requires lighting, sets, and a stage crew to put on a show, manufacturers have behind-the-scenes costs that support production and keep the business running. These overhead costs literally keep the lights on, the facility paid for, supervisors working, and more. They also have an important part to play in the following ways:

  • Cost assessment and pricing: Manufacturers must accurately allocate overhead costs to determine the true cost of producing each unit. Since overhead expenses are a crucial component of cost of goods sold (COGS), proper allocation enables accurate pricing and profitability analysis. Otherwise, the manufacturer could struggle to cover their costs and possibly turn a profit, if products are priced too low, or remain competitive, if prices are too high.
  • Budgeting and forecasting: The cost of producing each manufactured unit is another essential component of creating budgets and forecasts. Manufacturers require accurate data in order to project total production expenses, set realistic financial targets, and anticipate future cash flow needs. It also guides decisions about production capacity, since overhead costs change with volume; it informs expansion plans; and it helps businesses adapt to changing market conditions. For instance, if forecasts indicate rising overhead costs relative to production, a manufacturer might delay plans to scale up operations.
  • Operational efficiency: Mounting overhead costs can be a cue to manufacturers to investigate the causes and find ways to achieve greater efficiency. For instance, escalating utility costs might prompt energy-efficient equipment upgrades that, despite the initial investment, will save money in the long term. Similarly, an increase in equipment downtime due to repairs could highlight the need for a preventive maintenance program. These insights, gleaned from analyses of cost data, can lead to notable savings and productivity gains that will be reflected in a manufacturer’s bottom line.

What Factors Impact Manufacturing Overhead?

Indirect costs must be factored into overhead calculations to understand the true cost of production per unit and ensure that they don’t disproportionately affect the profitability of any single product. Here’s a close look at various components of manufacturing overhead.

  • Machine depreciation:

    Manufacturing equipment gradually decreases in value over time because of physical wear and tear, obsolescence, or other factors. For example, a $100,000 machine with a 10-year useful life would depreciate $10,000 annually, per the straight-line method of calculating depreciation. Depreciation must be properly accounted for in various financial statements and tax returns.

  • Indirect labor costs:

    The salaries and benefits of staff who support production but aren’t hands-on involved in product creation—such as plant managers, quality-control personnel, and security guards—contribute to indirect labor costs. Of note, these expenses can increase or decrease as production volumes fluctuate, for example, in the form of overtime pay.

  • Maintenance costs:

    Regular upkeep and repair of equipment can prevent costly breakdowns and emergency repairs. This can go a long way toward extending the useful life of the equipment and ensuring continued production of high-quality products, both of which can reduce long-term overhead costs. It also can improve workplace safety and energy efficiency. Scheduled preventive maintenance, condition-based maintenance, or predictive maintenance, steps that make use of Internet of Things sensors, are all solid approaches to keeping machinery in tip-top condition.

  • Utilities:

    Electricity, water, and gas are used throughout the production facility to power multiple jobs—and they all contribute to overhead costs. Utilities are variable or semi-variable expenses that must be carefully managed, not only to stay within budget but also for environmental sustainability. Manufacturers typically track utility expenses through cost pools, which are general ledger accounts that cover related types of overhead. This is helpful if analyses suggest, for example, that investment in energy-efficient equipment could save money over time, while also being better for the environment.

  • Rentals and leases:

    Rentals and leases of facilities and equipment are fixed monthly overhead costs that alleviate manufacturers from the burden of ownership and the initial capital outlay. Leasing a warehouse space for $5,000 per month, for instance, might be more economical than purchasing a facility outright, especially if production volumes fluctuate seasonally. Then again, it might not necessarily be an economically sound decision. Long-term analysis can help determine whether ownership would be more cost-effective in the long run; after all, mortgage payments are also classified as overhead.

  • Insurance:

    Premiums are typically fixed costs manufacturers pay to insurance companies for protection against potential losses. Property insurance that safeguards facilities and equipment, liability coverage that addresses potential harm to customers and third parties, and workers’ compensation that covers employee injuries or illnesses are examples. Insurance premiums vary from business to business, depending on the manufacturer’s size, location, level of risk, and other factors.

  • Regulatory costs:

    These overhead expenses are tied to compliance with industry regulations and standards, such as for obtaining permits, licenses, and inspections. Key regulatory bodies in manufacturing include the Occupational Safety and Health Administration (OSHA), Environmental Protection Agency, and Food and Drug Administration; adherence to these entities’ rules for workplace safety, environmental protection, and product quality, respectively, is mandatory to avoid the risk of steep penalties. For example, OSHA charges $16,550 for each serious and other-than-serious violation, and $165,514 per willful or repeated violation. Compliance is also important for maintaining consumer trust and ongoing operations.

  • External costs:

    Outsourced services or consultations, such as for quality-control testing or specialized technical support, are external costs that add to manufacturing overhead. Of note, these expenses can be outweighed by the long-term savings they generate. For example, if hiring an external consultant for process optimization at $10,000 per month results in a 5% reduction in overall monthly production costs of $250,000, it could lead to a net savings of $2,500 per month (a $12,500 savings minus the $10,000 consultant fee), or $30,000 annually.

How to Calculate Manufacturing Overhead

In an era where global competition and thin profit margins are common, the ability to accurately calculate, allocate, and manage manufacturing overhead is vital. It’s also a process ripe for software that can automate data collection, analysis, and reporting.

Manufacturing Overhead Formula

Manufacturing overhead is the total of all the indirect costs noted above over a given period of time. The formula for calculating total manufacturing overhead is:

Total manufacturing overhead = Sum of fixed, variable, and semi-variable indirect expenses

Example Manufacturing Overhead Calculation

TDM Manufacturing is a hypothetical midsize manufacturer of medical devices. Here is a breakdown of its overhead costs for the month of January, during which it produced 10,000 infusion pumps.

  • Indirect labor: $20,000
  • Indirect materials: $15,000 (e.g., safety goggles, lubricants, cleaning supplies)
  • Utilities: $5,000
  • Equipment depreciation: $10,000
  • Insurance: $2,000
  • Maintenance: $8,000
  • Regulatory compliance: $3,000

Added together, total manufacturing overhead in January is $63,000. To determine the per-unit cost, divide total manufacturing overhead by the number of units produced.

Manufacturing overhead per unit = Total manufacturing overhead / 10,000

TDM’s manufacturing overhead per unit equals $6.30 per unit. If, for example, the company reduces its energy consumption by 20% (saving $1,000 per month), its overhead cost per unit would decrease to $6.20—potentially increasing profitability or allowing for more competitive pricing.

What Is a Manufacturing Overhead Budget?

A manufacturing overhead budget estimates and allocates indirect production costs for a specific period, typically a year. It includes all anticipated manufacturing overhead costs and is created as part of a company’s master manufacturing budget, which also breaks down expenses for direct materials, direct labor, production, and selling and administrative expenses. Usually prepared by the accounting or finance department, in collaboration with other pertinent departments, the overhead budget can help prevent overspending, guide pricing decisions, and support overall financial planning.

Tips for Reducing Manufacturing Overhead

Manufacturers can chip away at their indirect expenses through process optimization, technology adoption, and resource realignment. No matter which of the followed tips are used, it is important to perform ongoing cost analysis and benchmarking against industry standards.

  • Invest in preventive maintenance: Regular, scheduled equipment maintenance can reduce unexpected breakdowns—manufacturers’ No. 1 challenge, according to UpKeep’s State of Maintenance report for 2024. This preventive approach minimizes costly downtime and helps machinery last longer.
  • Strengthen vendor relationships: Negotiating volume discounts and implementing vendor-managed inventory systems can help trim material costs and strengthen supply chain continuity. Long-term contracts and strategic partnerships are also beneficial.
  • Outsource support tasks: Delegating non-core manufacturing functions to specialized providers can cut administrative overhead and allow internal teams to focus on production priorities.
  • Go paperless: Intelligent document processing and other digital workflows that encourage manufacturers to use less paper can reduce operational costs. Savings come about through reduced manual data entry, filing, and retrieval, as well as, of course, costs for paper, ink, and printers.
  • Optimize scheduling: Tools that use artificial intelligence to align work shifts with production demands minimize idle time and overtime expenses. More predictable schedules can also improve employee satisfaction.
  • Reduce energy consumption: Smart sensors and LED bulbs that consume far less energy and last much longer than incandescent bulbs can trim long-term overhead expenses. Variable-speed drives, which adjust the frequency and voltage supplied to electric motors, as well as the use of renewable energy sources, also lower energy consumption.
  • Optimize floor space: A well-designed plant can increase operational efficiency—and lower overhead costs—merely by putting workers in closer proximity to the equipment, materials, and resources they need to perform their jobs effectively.
  • Lease out unused factory space: Renting excess capacity allows manufacturers to generate additional revenue while offsetting their fixed overhead costs. This tip can come in handy when regular production activities slow down, such as during off-peak production seasons or periods of lower demand.
  • Automate repetitive tasks: Automated systems can help reduce manufacturing overhead in a number of ways. Chief among them, technology, such as robotic process automation and enterprise resource planning (ERP) systems, can save on labor costs and reduce errors. And by performing tasks consistently and accurately, manufacturing automation limits the need for rework and improves overall production speed.

Simplify Manufacturing Operations With NetSuite ERP

By integrating financial planning with shop floor operations, NetSuite for Manufacturing provides real-time visibility into all areas of production, helping businesses track and optimize their indirect costs with precision. NetSuite’s cloud-based ERP features production planning, supply chain management, and shop floor control, all of which can help manufacturers reduce overhead by streamlining processes, optimizing resource allocation, and minimizing waste. The Quality Management module and real-time shop floor updates further help in identifying and addressing quality issues, thereby paring costs associated with rework and scrap. The result is a unified platform that transforms overhead management from a reactive accounting task into a proactive strategy that helps manufacturers maintain healthy margins and achieve operational excellence.

From equipment depreciation to utility bills and maintenance expenses, manufacturing overhead costs are essential to sustaining production but can often be overlooked or mismanaged. By effectively managing overhead, manufacturers can make better informed operational decisions and maintain a competitive edge in pricing to drive sustainable, long-term growth. So, whether you’re looking to refine your cost calculations or implement new technologies, mastering manufacturing overhead is one key to boosting operational efficiency and long-term success in today’s competitive manufacturing landscape.

#1 Cloud ERP
for Manufacturing

Free Product Tour

Manufacturing Overhead FAQs

Does COGS include manufacturing overhead?

Yes, manufacturing overhead is a key component of the cost of goods sold (COGS). It includes all of the indirect production costs, such as utilities, equipment depreciation, and indirect labor, that are necessary to manufacture products but cannot be directly traced to specific items. Properly allocating overhead ensures accurate COGS calculations and prevents underpricing.

What’s not included in manufacturing overhead?

Manufacturing overhead excludes any expense directly tied to the production of specific products. Additionally, nonmanufacturing costs, such as administrative expenses, marketing, and distribution, are also excluded from overhead calculations.

What is an example of nonmanufacturing overhead costs?

Nonmanufacturing overhead costs include expenses unrelated to the production process, such as office rent, executive salaries, sales commissions, and marketing expenditures. For instance, customer service or advertising expenses would fall under nonmanufacturing costs, as they support the business but don’t contribute to actual production.

What is a good overhead percentage for manufacturing?

This will vary according to industry, company size, and level of automation. Capital-intensive industries might have higher percentages due to substantial depreciation and maintenance costs. Keeping this percentage low, while maintaining operational efficiency, is key to staying competitive.

Is salary a manufacturing overhead?

It depends on the role. Salaries for indirect labor—such as supervisors, maintenance staff, or quality control personnel—are considered manufacturing overhead. However, salaries for direct laborers working on the production lines are categorized as direct labor costs. The key distinction is whether or not the employee directly participates in transforming raw materials into finished products.