How to Calculate Overhead Rates for Your Firm

Calculating your overhead rate is simple on the surface: just divide your total indirect costs by some measure of business activity, like total labor hours or even revenue. This single number reveals the true cost of keeping your doors open and is the key to accurately pricing your services for profitability.

Why Your Overhead Rate Is a Profitability Powerhouse

Knowing your overhead rate isn’t just a routine accounting task—it’s a powerful tool for making sharp, strategic decisions. Think of it as the hidden cost lurking behind every billable hour your team works. Without a firm grasp on this figure, you’re basically pricing your projects in the dark, just hoping you’ve covered all your bases.

When firms get this wrong, the consequences can be brutal. Let’s say you underbid on a project. You might win the work—which feels great at first—but you’ll slowly bleed out your profit margins. On the flip side, overpricing because of a bloated or misunderstood rate can make you uncompetitive, causing you to lose bids you should have won.

From Backward-Looking Data to Forward-Thinking Strategy

A precise overhead rate transforms your financial data from a historical record into a predictive tool. It gives you the confidence to budget for future projects, protect your margins, and steer your firm toward sustainable growth. It’s the difference between reacting to financial outcomes and actively shaping them.

For instance, knowing your rate helps you answer critical questions that pop up all the time:

• Is this project actually profitable? It helps you see beyond direct costs to understand the full financial weight of the work.
• Can we afford to hire another non-billable employee? You can model how a new office manager will impact your rate and overall pricing.
• Where can we tighten the belt? A high overhead rate can be a glaring sign that it’s time to cut unnecessary expenses, like redundant software subscriptions.

To put it all together, here’s a quick rundown of the core concepts.

Table: Core Concepts of Overhead Rate Calculation

Component	What It Is	Why It Matters for Your Firm
Overhead Costs	All indirect business expenses not tied to a specific project (rent, software, admin salaries).	These are the “hidden” costs of doing business. Ignoring them leads to underpricing and lost profits.
Allocation Base	The metric used to apply overhead costs to projects (e.g., direct labor hours, direct labor cost).	The right base ensures costs are distributed fairly and accurately, reflecting how your firm actually works.
Overhead Rate	The calculated rate (costs ÷ base) used to allocate overhead to each project.	This is the key that unlocks true project costing, enabling you to price for sustainable profitability.

Getting these three components right is foundational to building a financially healthy and scalable consulting firm.

The Modern Benchmark for Success

In today’s professional services world, overhead calculations have become the backbone of profitability. By 2025, many design studios and consulting firms have started expressing this rate as a percentage of revenue for easier benchmarking. Imagine a firm with $40,000 in overhead against $200,000 in revenue—that’s a crisp 20% rate. It means 20 cents of every dollar earned goes to cover those indirect costs.

This thinking aligns with trends in construction and engineering, where historical overhead recovery rates often average 25-30%, a figure that directly influences how multi-phase project bids are put together. If you want to see how this plays out in the real world, you can explore the 2024 primer on Wall Street Prep’s blog.

Your overhead rate is more than just a number; it’s a health metric for your business. It tells a story about your efficiency, your pricing strategy, and your potential for long-term success. Mastering this calculation is the first step toward building a more resilient and profitable firm.

Identifying All Your Indirect Costs

Before you even touch a calculator, you need a painfully clear picture of what you’re adding up. Calculating an overhead rate is a classic “garbage in, garbage out” situation. If your list of indirect costs is spotty, your final rate will be wrong, leading to shaky pricing and budgets that are doomed from the start.

Indirect costs are all the things you have to pay for just to keep the lights on and the business running—the expenses that aren’t tied to one specific client project. Think of them as the operational bedrock of your firm. They don’t directly bring in revenue, but without them, you couldn’t deliver your services.

Where to Find Your Indirect Costs

Your first stop on this scavenger hunt is your firm’s profit and loss (P&L) statement. This report is a goldmine, laying out your revenues and, more importantly, all your expenses over a specific time frame (usually a month, quarter, or year).

Start combing through the line items under “Expenses” or “Operating Expenses.” Be methodical. Pull out every single cost that isn’t directly billable to a client. This means everything from the big-ticket items down to the small, recurring charges that can add up faster than you’d think.

For a clearer view, many firms find that dedicated project management and accounting platforms make it much easier to cleanly separate direct from indirect expenses.

As a rule of thumb, a healthy overhead ratio shouldn’t really climb above 35% of your total revenue. If you tally up your costs and find yourself way over that mark, it’s a huge red flag that your operational spending needs a closer look.

A Comprehensive Checklist for Professional Service Firms

To make sure nothing slips through the cracks, it helps to group your indirect costs into logical categories. This doesn’t just simplify the math; it also makes it way easier to spot trends and areas where you might be able to save some money down the road.

Here’s a practical checklist built for consulting, creative, and other professional service firms:

1. Facilities and Utilities These are the costs tied to your physical (or virtual) office space.

• Office rent or mortgage payments
• Utilities (electricity, water, internet)
• Property taxes and building insurance
• Repairs, maintenance, and cleaning services

2. Administrative and Support Salaries This bucket covers the wages and benefits for your non-billable team members—the people who make the work possible.

• Salaries for admin staff (office managers, bookkeepers)
• Wages for your marketing, sales, and HR people
• Benefits contributions (health insurance, retirement plans) for non-billable staff
• Payroll taxes for these employees

3. General and Administrative Expenses This is a catch-all for all the other day-to-day operational costs.

• Office supplies (paper, pens, printing)
• Business insurance (professional liability, general liability)
• Bank fees and credit card processing charges
• Fees for your lawyer and accountant

4. Technology and Software For modern firms, this is a major and often underestimated category.

• Software subscriptions (like Drum, Adobe Creative Suite, or your CRM)
• Computer hardware depreciation or leases
• IT support contracts and services
• Website hosting and domain registration fees

5. Marketing and Business Development These are the costs you incur to win new business and keep the pipeline full.

• Advertising and promotional campaigns
• Website development and ongoing maintenance
• Client entertainment and networking events
• Professional association memberships and dues

By meticulously gathering and categorizing these expenses, you build a solid, accurate foundation. This total figure becomes the numerator in your overhead rate formula—and it’s the key to unlocking a calculation you can actually rely on.

Choosing the Right Allocation Base for Your Business

Okay, you’ve done the hard work of corralling all your indirect costs. You’re holding one half of the overhead equation. The next part is just as critical: picking the right allocation base.

Think of the allocation base as the yardstick you’ll use to fairly spread those overhead costs across your client projects.

Making a smart choice here is everything. This is what connects your general business expenses—like rent, software, and admin salaries—to the specific work that actually earns you revenue. A poorly chosen base can seriously distort your project costs. You might end up thinking some projects are wildly profitable when they’re actually bleeding you dry, while unfairly penalizing others.

The goal is to pick a driver that logically mirrors how your firm actually consumes its resources.

The Most Common Allocation Bases

For most professional service firms, the choice usually boils down to a few tried-and-true options. Each one has its own logic, and they’re better suited to certain types of businesses. Let’s break them down with some real-world context.

1. Direct Labor Hours

This is probably the most common and straightforward allocation base out there. It simply distributes overhead based on the number of hours your billable team members work on a given project.

• Best for: Firms where the intensity of the work and the resources used are pretty consistent across all projects and employee roles. If your value is delivered primarily through your team’s time and expertise—think creative agencies, business consultancies, and many architecture firms—this is a strong contender.
• Example: A marketing agency has $100,000 in annual overhead and they project 10,000 total direct labor hours for the year. This gives them a simple overhead rate of $10 per direct labor hour. When a project comes along that requires 50 hours of work, they’ll apply $500 in overhead to that job.

2. Direct Labor Costs

Instead of hours, this base uses the actual payroll cost of the employees working on a project. This method allocates more overhead to projects that rely on more senior (and therefore more expensive) team members.

• Best for: Firms with a wide range of staff seniority and pay scales, like engineering or law firms. If a project needs significant oversight from a high-salaried principal engineer, this method makes sure it carries a proportionally larger share of the overhead burden.
• Example: An engineering firm is looking at $300,000 in overhead against $600,000 in direct labor costs. Their rate is 50% of direct labor cost. So, for a project with $20,000 in direct labor, they would apply $10,000 in overhead.

For either of these methods to work, you absolutely need precise time logging. A rock-solid system for tracking time isn’t just a nice-to-have; it’s a non-negotiable prerequisite. It’s what gives you the clean data needed for an accurate calculation. Using tools with built-in time tracking for consulting firms can make this process a whole lot less painful.

3. Machine Hours

While less common in pure consulting, this base is perfect for firms that lean heavily on expensive, specialized equipment to get the job done.

• Best for: Any business where technology and machinery are significant cost drivers. Think of a 3D rendering studio, a data analytics firm with massive server costs, or a video production house running complex edits.
• Example: A video production company has $50,000 in overhead tied directly to their editing suites. They anticipate 2,000 hours of machine use this year. That sets their rate at $25 per machine hour. A project that needs 10 hours of editing time will have $250 in overhead applied to it.

Choosing your allocation base isn’t just an accounting decision—it’s a strategic one. It fundamentally defines how you understand profitability at the project level. Take the time to really consider which metric best reflects how your firm’s resources are truly consumed.

A Modern Perspective on Allocation

The crucial role of the allocation base was thrown into sharp relief back in 2020. During the pandemic, consulting firms were grappling with skyrocketing remote-work overheads, which made having predetermined rates essential for survival.

This whole approach of dividing estimated overhead by an allocation base actually evolved from post-WWII manufacturing, a time when direct labor made up 50-60% of total costs. Fast forward to today, and it’s just as relevant for creative studios where labor’s share of costs had dipped below 20% by 2018, thanks in large part to the rise of AI tools. For a modern take on these historical trends, you can read more about how to calculate a predetermined overhead rate on Flxpoint.com.

How to Calculate Overhead Rates with Different Methods

Alright, you’ve got your indirect costs totaled up and you’ve picked your allocation base. Now for the fun part: putting it all together.

Calculating your overhead rate isn’t a one-size-fits-all deal. The right method really hinges on your firm’s complexity, the mix of services you offer, and just how granular you need to get with your project costing.

Let’s walk through three common approaches, starting with the simplest and working our way up to the most precise. We’ll use real-world examples from professional services to show you exactly how each one works.

The Single Plantwide Overhead Rate Method

The most straightforward way to go is the single plantwide overhead rate. This method is exactly what it sounds like: you pool all your indirect costs into one big bucket and spread them evenly across the entire firm using a single allocation base, like direct labor hours or direct labor costs.

This is a fantastic starting point for smaller or less complex firms. If your projects and teams tend to use similar resources and follow a consistent workflow, this method gives you a solid, reliable rate without getting bogged down in painful calculations.

Example: A Boutique Architecture Firm

Let’s take a small architecture firm, “Apex Designs.” They’ve run the numbers and figured out their total annual overhead is $250,000. After looking at how they work, they’ve decided direct labor hours is the most logical way to allocate those costs. The team is projected to log a total of 20,000 direct labor hours for the year.

The math is simple:

• Formula: Total Overhead Costs / Total Direct Labor Hours
• Calculation: $250,000 / 20,000 hours = $12.50 per direct labor hour

What this means is that for every hour an architect or drafter works directly on a client’s project, Apex Designs applies $12.50 to that project to cover its share of the overhead. A project that racks up 100 direct labor hours will have $1,250 in overhead costs assigned to it. Simple as that.

The process of gathering these costs and choosing a base is really the foundation for any overhead calculation you do.

This visual captures the essential flow—from cost gathering to allocation—which is at the heart of any overhead calculation method you choose.

The Departmental Overhead Rate Method

As firms grow, they naturally develop specialized departments that consume resources at very different rates. Your engineering team might chew through expensive software licenses and powerful hardware, while your field survey team’s costs are driven more by vehicle mileage and equipment maintenance.

When this happens, a single plantwide rate can seriously distort your project costs.

The departmental overhead rate method solves this by creating a separate, unique overhead rate for each department. This approach gives you a much more accurate picture of what it truly costs to deliver services from different parts of your business.

Example: A Mid-Sized Marketing Agency

Imagine “Momentum Marketing,” an agency with two key departments: a Creative team and a Digital Strategy team. Each one has its own specific overhead costs and, crucially, a different driver for those costs.

• Creative Department:
  • Overhead: $120,000 (think specialty software, stock photo subscriptions, freelance artist fees)
  • Allocation Base: 20,000 Direct Labor Hours
  • Rate: $120,000 / 20,000 hours = $6 per direct labor hour
• Digital Strategy Department:
  • Overhead: $80,000 (analytics tools, server costs, SEO software)
  • Allocation Base: 1,000 Machine Hours (for running data-intensive analytics)
  • Rate: $80,000 / 1,000 hours = $80 per machine hour

Now, when pricing a new project, Momentum Marketing applies the specific rates. A project that needs 30 creative hours and 5 machine hours for data processing would have $580 in overhead applied (30 x $6 + 5 x $80). This is far more accurate than what a blended, single rate would have produced.

In the world of consulting, accurately calculating overhead rates has been a massive focus since automation tools like Drum began changing project management. Even the traditional predetermined overhead rate formula—simply estimated total overhead divided by an estimated allocation base—is a powerful tool. A firm budgeting $200,000 in overhead against 40,000 projected direct labor hours gets a rate of $5 per hour. This allows firms to apply overhead in real-time for bids and project tracking, without waiting for end-of-year numbers. You can dig deeper into this traditional allocation method with these insights provided by OpenStax.

Activity-Based Costing (ABC)

When you need the absolute highest level of precision, especially in a complex firm with diverse services, you’ll want to look at Activity-Based Costing (ABC). Instead of using broad departmental buckets, ABC breaks your overhead down into very specific activities. Costs are then assigned based on how much each project consumes those activities.

Activity-Based Costing is about tracing costs, not just allocating them. It provides a granular view that connects your overhead spending directly to the actions required to serve your clients.

Fair warning: this method is more involved. But the payoff is often stunning insights into the true profitability of different services, clients, or project types.

Example: A Multidisciplinary Engineering Firm

Let’s look at “Vector Engineering,” a firm that handles both client project work and intensive internal quality assurance reviews. They’ve identified two key overhead activities that drive significant cost:

1. Project Management: Includes costs like scheduling software, admin support, and the salaries of project coordinators.
2. Quality Assurance (QA) Reviews: Includes the cost of specialized testing equipment and the QA manager’s time.

Vector digs into their numbers and finds:

• Total Project Management costs are $150,000, driven primarily by the sheer number of projects. They expect to run 100 projects this year.
• Total QA Review costs are $75,000, driven by the number of individual reviews performed. They anticipate doing 250 reviews.

This analysis lets them create activity-specific rates:

• Project Management Rate: $150,000 / 100 projects = $1,500 per project
• QA Review Rate: $75,000 / 250 reviews = $300 per review

With these rates, a large, complex project that requires four separate QA reviews would have $2,700 in overhead applied ($1,500 for project management + 4 x $300 for reviews). A smaller, simpler project with just one review would only have $1,800 applied. ABC ensures that the most resource-intensive projects carry their fair share of the costs, giving you unparalleled clarity on where your money is really going.

Comparing Overhead Rate Calculation Methods

Choosing the right approach comes down to balancing accuracy with effort. Here’s a quick overview to help you decide what’s best for your firm.

Method	Best For	Complexity	Key Advantage
Single Plantwide Rate	Small firms or those with uniform services and processes.	Low	Simple to calculate and easy to apply.
Departmental Rate	Growing firms with distinct departments that use resources differently.	Medium	More accurate costing than a single rate without being overly complex.
Activity-Based Costing (ABC)	Complex firms with diverse services and a need for precise profitability analysis.	High	Provides the most accurate picture of true project and service costs.

Ultimately, the goal is to find a method that gives you the insight you need without creating an administrative nightmare. You can always start simple and move to a more detailed method as your firm grows and your needs evolve.

Putting Your Overhead Rate to Work

Right, you’ve crunched the numbers and have a shiny new overhead rate. Good work. But that’s just the starting line. The real value comes from weaving this number into the very fabric of your daily operations. This is the moment your calculation transforms from a spreadsheet exercise into a powerful tool that actively guards your profit margins on every single project.

Applying your rate isn’t about adding another layer of admin. It’s about integrating it into the systems you and your team already live in, turning abstract financial data into concrete, actionable insights. You want to build a workflow where profitability isn’t an afterthought you check at the end of the month, but a constant, visible pulse guiding your decisions.

Weaving Your Rate into Daily Workflows

The goal here is to make your overhead rate an invisible, seamless part of your project management and accounting. It shouldn’t feel like a chore. Instead, it should empower your team with the data they need to run projects profitably from kickoff to the final invoice.

Everything starts with your time-tracking system. Your overhead rate is only as reliable as the data that feeds it. This means you need a crystal-clear, consistent way to capture not just billable hours, but also all the time spent on those essential non-billable, indirect activities.

A simple way to get this right is to set up specific non-billable codes in your time-tracking software. This gives everyone a structured way to log time spent on things that keep the lights on but aren’t tied to a specific client.

• Administrative Tasks: This is for time spent on internal meetings, scheduling, or general admin.
• Business Development: Use this for hours dedicated to writing proposals or attending networking events.
• Professional Development: This bucket is for training, certifications, or industry conferences.

By tracking this time religiously, you’re not just logging hours; you’re gathering the precise data needed to sharpen your overhead calculations down the road. It also paints a clear picture of where your team’s non-billable time is going—a goldmine of insight for boosting operational efficiency.

Setting Up a Powerful Feedback Loop

One of the most valuable moves you can make is to stop treating your overhead rate as a “set it and forget it” number. Your business is alive—teams grow, costs fluctuate, new software gets adopted. Your overhead rate needs to keep up.

Don’t just calculate your rate once a year and call it a day. A simple but powerful habit is to compare your budgeted overhead with your actual overhead spending every month or quarter. This creates an early warning system, helping you spot trouble before it has a chance to quietly eat away at your margins.

Think of your overhead rate not as a static number etched in stone, but as a living metric. Regularly checking its pulse against real-world spending is what keeps your pricing sharp and your projects profitable. As a rule of thumb, a healthy overhead ratio shouldn’t creep past 35% of your total revenue, and this constant monitoring helps you stay in the green.

When you spot a significant difference, that’s your cue to dig in. Did a new software subscription sneak in and bump up your monthly costs? Did the team spend way more time on that big proposal than you planned? Answering these questions lets you make proactive adjustments.

Maybe you need to tweak your overhead rate for the next quarter, find a few places to trim indirect spending, or adjust your pricing on future proposals. This continuous cycle of applying, monitoring, and adjusting is how you turn your overhead rate into a dynamic financial rudder for the business.

For many firms, the final piece of the puzzle is connecting this operational data directly to their accounting software. This ensures the rates you apply to projects are accurately reflected in your financial reports and invoices. If you’re looking to tighten up that process, our guide on how to streamline invoicing in QuickBooks Online is a great place to start.

Ultimately, putting your overhead rate to work is about fostering a culture of financial awareness. When your whole team understands how their time—both billable and non-billable—impacts the firm’s health, everyone is empowered to make smarter decisions that protect profitability and fuel sustainable growth.

Answering Your Overhead Rate Questions

Even with a solid guide, putting overhead rates into practice can throw a few curveballs your way. It’s completely normal to have questions pop up as you get into the weeds. Let’s tackle some of the most common ones we hear from firms just like yours.

How Often Should I Recalculate My Overhead Rate?

Think of this as an annual check-up, at a minimum. You should definitely sit down and recalculate your overhead rate at least once a year, usually when you’re mapping out your annual budget. This keeps your rate in sync with what you expect to spend and earn in the coming year.

That said, your overhead rate isn’t something you can just “set and forget.” You absolutely need to revisit it if your business goes through a major change. Key triggers for a recalculation include things like:

• Moving to a new office with a different rent.
• Hiring a few new non-billable team members, like an office manager or a marketing specialist.
• Making a big investment in new software or equipment that changes your monthly expenses.
• Seeing a major, unexpected swing in your project pipeline.

The whole point is to keep your rate reflecting your current business reality. An old, outdated rate is a direct path to wonky project pricing and misleading profit reports.

The biggest mistake you can make with your overhead rate is treating it like a static number. Your business is always evolving, and your rate needs to evolve with it. A quick quarterly review can be the difference between a profitable year and one spent wondering where the money went.

What Should I Do If My Overhead Rate Seems Too High?

First off, don’t panic. A high overhead rate isn’t a sign you’re failing; it’s a powerful signal that it’s time to dig into your operational efficiency. Before you start slashing costs, though, double-check your math. It’s surprisingly easy to accidentally sweep a direct cost into your overhead pool, which can throw the whole calculation off.

If the numbers are right, then a high rate is your cue to start optimizing. Get forensic with your indirect expenses. Do you have software subscriptions you’re not really using? Can you renegotiate terms with a key vendor? Are your internal admin processes as lean as they could be? More often than not, a high overhead rate shines a spotlight on opportunities to trim waste and make your business run smarter.

Should Employee Benefits Be Included in Overhead Costs?

This is an excellent question, and the answer comes down to one thing: the employee’s role. Being consistent here is absolutely crucial for getting an accurate number.

For your direct, billable employees—the consultants, designers, or engineers doing the client work—their benefits are typically rolled into their fully-burdened direct labor cost. It’s a direct cost of delivering the project.

But for your indirect, non-billable staff—think office managers, marketing coordinators, or bookkeepers—their benefits absolutely belong in your total overhead costs. Their work supports the entire firm, not a specific project, which makes their benefits a classic overhead expense.

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