Why overhead rate matters to a first-time founder
A sensible rate reveals the shared costs each job must help recover. A poor activity base can overprice simple work and underprice demanding work, so the choice of labour hours, machine hours or another driver matters as much as the calculation.
Examples of overhead rate
A workshop expects £120,000 of annual overhead and 6,000 machine hours. Its predetermined overhead rate is £20 per machine hour. A job using 30 hours receives £600 of allocated overhead before the business assesses its full cost.
Common misunderstanding
It is not the same as the overhead ratio, which compares overhead with revenue or another total. An overhead rate allocates costs using an activity base. It is an estimate when based on forecast costs and activity.
When to use it
Use it when pricing repeatable work, estimating inventory costs or comparing job profitability. Choose a driver that actually causes the cost and review the rate when activity changes. Very small businesses may use a simpler allocation if precision adds little value.