Overhead rate

The overhead rate expresses the indirect costs of a business as a proportion of its direct costs, so that they can be carried into prices and project calculations. Indirect means everything that cannot be attributed to a single project: rent, administration, software, management and sales.

How is an overhead rate calculated?

Indirect costs divided by direct costs, for a period. A business with 600,000 euros of direct personnel cost and 240,000 euros of indirect cost has an overhead rate of 40 per cent, which is then added to the direct cost of a project to find its full cost.

Why is an overhead rate needed at all?

Because a project that covers only its direct cost loses money. Contribution margin shows what a project adds towards overhead, and the overhead rate is what tells you how much there is to cover. Indirect means everything that cannot be attributed to a single project: rent, administration, software, management and sales.

What goes wrong with overhead rates?

They get set once and left. If the business grows, the mix of work changes or the billable share falls, a rate from two years ago quietly understates the real cost of every project priced with it. Because the rate carries indirect costs into prices and project calculations, every one of them inherits the error.

Should every project carry the same overhead rate?

Not necessarily. Work that consumes more administration, more travel or more management attention carries more overhead in reality. A single rate is simpler and defensible, several are more accurate and harder to maintain. Each rate is still indirect costs divided by direct costs, added to a project's direct cost to find its full cost.

troi reports cost and margin per project, client and service line. See reporting and controlling.