Underapplied Overhead

and finance Allah shmoop properly accounting for overhead And yes

it's an important question for very tail Giants and N

BA centers are also key question for business owners Will

you run a business that makes candles scented like particular

cities You know for people who have moved away and

gotten homesick You have your Brooklyn coffee shop model your

Dubai Lamborghini dealership model there your Paris and San Francisco

St Urine model Each candle cost you twelve bucks to

make and they sell for thirty each That twelve dollars

represents what's called any accounting world Caw gse Nora cost

of goods sold well It encompasses the direct expenses that

go into making the candles You know the wax the

wick the glass holder the artificial and natural ingredients needed

Teo make the smell It also includes things like direct

labor and all the other costs that you Khun directly

attribute to each candle But those CAW GSE expenses don't

account for everything You've got a whole set of other

costs that get incurred for things outside of the production

process You've got the accounting in HR departments You've got

the R and D lab constantly trying to match smell

combinations with different cities You've got the fleet of executive

private jets and a small island in the Caribbean where

you hold your annual too weak you know think sessions

These things cost the company money but you can't assign

the expenses to any particular candle thes air known as

Yes overhead costs Yeah because a while to get to

the title there But we did in accounting speak They

get a special name They're known as SG any expenses

or sales general and administrative expenses So we're talking stuff

related to sales or admin obviously plus anything that applies

to the company in general I eat not to any

particular product So like for your candle company these overhead

costs Mike total five million bucks a month You have

to pay those expenses those overhead expenses whether you sell

one candle or yourself five million the overhead does not

change based on your sales volume But you have to

sell enough candles to reach that five million dollar mark

Otherwise well you post a loss for that month enough

losses in a row and well you'LL run out of

money and then the b word bankruptcy Remember you're selling

candles for thirty bucks that cost twelve bucks to make

The thirty represents your revenue That twelve represents your cog

which leaves eighteen left Poor candle for everything else So

that eighteen dollars is known is the gross profit It's

the prophet you earn from each candle net not counting

the overhead cost The gross profit represents the first off

along the income statement You started revenue and go through

COGSA and then you end up at the gross profit

right there Well the next step takes care of the

S g N A Expenses You sell half a million

candles in a month Each one is worth a gross

profit of eighteen bucks there That's nine million dollars in

total gross profit for that month Well you have five

million in overhead right It's sixty million a year to

run your business Those DNA expenses all told five million

a month So what does that get you while you

got nine million gross there minus the five million and

overhead and that gives you four million bucks after overhead

Well that four million dollars number represents what's called your

operating profit or pretax profit If you want to know

you're operating margin Well you just relate that number to

the revenue figure like that So you sold five hundred

thousand candles at thirty bucks each Total revenue fifteen million

dollars With that sales lovely ended up with four million

in operating profit and four million divided by fifteen million

gives you an operating margin about twenty six point seven

Some like that So when you sold five hundred thousand

candles you paid all the expenses needed to make the

product Then he paid all your overhead which left you

with four million dollars over twenty six point seven percent

of your total revenue wealth To figure out your break

even point you just have to work through the process

backwards You have five million dollars in overhead you have

to pay for well Each candle gives you a gross

profit of eighteen dollars So the question How many eighteen

dollars bits of gross profit do you need to pay

for five million in overhead We just divide that five

million by eighteen and that gets you roughly two hundred

seventy seven thousand eight hundred seventy eight thousand candles That's

your break even production level Sell that many candles and

you'LL pay your overhead All sales beyond that point Well

generally fall to the bottom line like through that n

ba center Yeah you need to make sure all the

door jams and ceilings in your house or at least

eight feet tall Then you don't have to worry about 00:04:19.614 --> [endTime] you know bumping into that overhead