More About Allocated Overhead

Let’s expand a little on the allocated overhead component of the pricing formula with an example. There are two pieces of information you need to calculate allocated overhead: how many orders you fill each year, and how much you spend in overhead annually.

Let’s say you are getting ready to launch a new home-based bakery business, so since you have no actual sales history to determine annual volume you estimate that you will be selling two wedding cakes per week on average. Your estimated annual volume would be 100 orders, leaving two weeks a year for vacation.

Looking at the overhead spending for your first year (which you should already have budgeted), you might have $400 for insurance, $100 for the city business license, $200 for a cottage food license, $400 for accounting and legal fees, $1800 for advertising ($150/month, including web site costs), $600 in additional utility costs ($50/month), and $600 in supplies & depreciation, which includes the cost of replacing worn out supplies and buying new general use supplies throughout the year. That’s a total of $4000/year.

Divide your annual overhead total of $4000 by the number of orders per year (100) and you come up with an allocated overhead cost of $40 per order. So if the ingredients for a wedding cake cost $60, you will be spending ten hours total on the order, and you pay yourself $15/hour, the total for ingredients and labor would be $60 + (10 * $15) = $210. Then you would add allocated overhead of $40 (which would typically be the same for every order) to bring the true cost up to $250. Adding a 20% markup for profit gives you a final price of $300.

If you have a different business model and focus on a higher volume of smaller orders, you would be able to spread out the overhead cost across more sales throughout the year. Assuming a volume of 10 orders per week, or 500 per year, the $4000 in annual overhead would work out to just $8 per order.

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4 Comments

Filed under Marketing, Pricing

4 responses to “More About Allocated Overhead

  1. bakerbee7468

    This is just what i needed. So I’m assuming that when it comes to utilities in my home business, I’ll need to know how much i pay in utilities before i start my business and how pay attention to how much I’m paying after i start on average and the difference is the amount i use in my overhead….??

    • Comparing your utility bill before and after you start your business is probably the easiest way to determine the incremental utility cost…you’ll want to look at the cost vs. the same month last year to avoid seasonal effects while adjusting for rate increases. Another way to approach this would be to build the utility cost into each product by looking at the baking and mixing time required for the recipe and the cost to run your oven/mixer (or any other high wattage appliance) for that amount of time.

  2. Kayla

    Very helpful! thank you!

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