What is the general overhead rate?

The general overhead rate expresses total indirect costs as a percentage of a base measure (typically direct labor). It is used to allocate overhead to projects and to calculate fully loaded costs. For professional service firms, the overhead rate indicates how much indirect cost must be recovered through pricing for each dollar of direct labor. Lower rates indicate more efficient operations; higher rates require higher markups to maintain margins.

Key characteristics

• Expresses overhead as a percentage of direct labor

• Used to allocate costs and calculate loaded rates

• A lower rate indicates more efficient operations

• Should be tracked and benchmarked

• Directly impacts pricing requirements

• Common range for service firms: 40% to 80%

Why it matters for professional service firms

The general overhead rate directly affects pricing competitiveness and margin requirements. A firm with an 80% overhead rate needs higher billing rates than one with a 50% overhead rate to achieve the same margin. Professional service firms should track the overhead rate as an efficiency indicator and benchmark against peers. High rates warrant investigation: Is overhead too high, or is direct labor too low (utilization issue)? Managing overhead rate improves both competitiveness and profitability.

Real-world example

Sarah's firm had a general overhead of $380K on $520K direct labor (73% overhead rate). Industry benchmark was 50% to 60%. Investigation revealed: premium office space drove rent 40% above market rates; administrative staff was higher than needed for the firm's size; and multiple overlapping software subscriptions. Overhead reduction initiative: relocated to appropriate space (saved $48K), right-sized admin through natural attrition (saved $35K), consolidated software (saved $18K). Overhead dropped to $279K (54% of direct labor). The 19-point reduction in the overhead rate significantly improved competitiveness and margins.