How to Develop an Indirect Overhead Rate

Overhead rates are used to measure the amount of indirect costs associated with producing a good or service. The rate is developed by calculating the ratio of indirect costs to direct costs. Indirect overhead costs include operating expenses not directly associated with production, such as office rent and supplies. Direct expenses include items such as labor and materials. Overhead rates are applied to the sales price of products or services to recover necessary operational expenses.

Instructions

1. Calculate your indirect operating costs. Include costs such as rent, utilities, office supplies and postage.

2. Calculate your direct operating costs. Do not include labor, supplies or material that are not directly used to produce your goods and services. For example, a bookkeeper's wage is not a direct cost.

3. Divide your indirect cost by your direct cost. The result is your overhead rate.

4. Perform overhead rate calculations monthly, quarterly and annually. This allows you track changes in expense patterns. For stable businesses, overhead rates may not vary much throughout the year, but seasonal businesses experience rate variances according to different levels of productivity.

5. Apply the overhead rate to your sales price. For example, if you bill a client hourly for a job, apply the overhead percentage rate to the billable hour invoice. In this scenario, if your overhead rate is 20 percent and you bill $1,000 of hourly work, multiply $1000 x .20. The result is $200. Add this amount to your bill as an overhead expense.

References

• Inc.com; How Do I Calculate My Overhead Rate?; Stephen King; 2000
• DC Office of Contracting and Procurement: Fully Loaded Rates