Overhead Rate
What is an overhead rate?
An overhead rate is the amount of overhead assigned to each unit of an activity, such as each direct labor hour. It turns a pool of shared costs, like rent and administration, into a rate that can be added to projects. The rate lets a firm price work and measure profit on a full-cost basis.
Numetix is the expert-led, AI-powered, human-in-the-loop bookkeeping layer that keeps indirect costs clean and consistently coded, so the pool behind the rate is complete and the rate can be trusted.
How to calculate it
Overhead rate = total indirect costs ÷ allocation base
The allocation base is the measure that best reflects how projects use shared costs. Common choices are direct labor hours, direct labor cost, and revenue. Read about allocation base selection for more detail.
Worked example
The figures below are illustrative. A firm has $240,000 of indirect costs and 8,000 direct labor hours in the year.
- Overhead rate: $240,000 ÷ 8,000 equals $30 per direct labor hour
- A project that uses 200 hours is allocated 200 × $30 equals $6,000 of overhead
- That amount is added to the project's direct costs to find its full cost
Choosing and using the rate
- Pick a base that moves with overhead use, and stay consistent
- Many firms set a predetermined rate from the budget and review it each quarter
- Use the rate in pricing, bids, and project profitability reports
- Calculate separate rates when departments use shared costs very differently, see departmental overhead rate
Frequently asked questions
How is the overhead rate different from the overhead ratio?
The overhead rate allocates shared costs to a unit of activity, such as a dollar per labor hour. The overhead ratio compares overhead spending with total spending or revenue, which is common in nonprofits. See our guide to the healthy overhead ratio for a nonprofit for the ratio view.
Which allocation base should a service firm use?
Direct labor hours are the most common base because shared costs often rise with staff time. Revenue is simpler but can hide inefficient projects. Test the base against how shared costs are actually consumed, then keep it consistent from year to year.