The formula: overhead rate and the markup that recovers it
Overhead is the cost of running the company that no single job causes, such as office rent, office salaries and accounting. It is budgeted for the year and recovered by adding a rate to each job. Direct cost is what jobs cause: labor, materials, equipment and subcontracts.
- Overhead rate = annual overhead ÷ planned base, where the base is the year's direct cost or its direct labor.
- Job overhead = overhead rate × the job's base.
- Markup on direct cost that recovers overhead = job overhead ÷ job direct cost. On a direct-cost basis this is the rate itself.
- Bid = (direct cost + overhead) × (1 + profit), with profit as a markup on cost plus overhead.
Worked example 1: spread over direct cost
Annual overhead is budgeted at $420,000 and the company plans $3,500,000 of direct cost for the year. A job has $180,000 of direct cost and profit is 8% on cost plus overhead. These are invented study numbers, the calculator's starting example and the example in the job costing guide.
- Overhead rate = 420,000 ÷ 3,500,000 = 12% of direct cost, so the markup that recovers overhead is 12%.
- Job overhead = 180,000 × 0.12 = $21,600.
- Cost plus overhead = 180,000 + 21,600 = $201,600.
- Profit = 201,600 × 0.08 = $16,128.
- Bid = 201,600 + 16,128 = $217,728.
Check: 3,500,000 × 0.12 = 420,000, and the bid as one markup is 180,000 × 1.12 × 1.08 = 180,000 × 1.2096 = 217,728. Overhead and profit together are 37,728 ÷ 217,728 = 17.33% of the bid.
Worked example 2: spread over direct labor
Annual overhead is $300,000 and the company plans $750,000 of direct labor for the year. A job has $80,000 of direct cost, of which $30,000 is labor, and profit is 10% on cost plus overhead.
- Overhead rate = 300,000 ÷ 750,000 = 40% of direct labor.
- Job overhead = 30,000 × 0.40 = $12,000.
- Markup on the job's direct cost = 12,000 ÷ 80,000 = 15%.
- Cost plus overhead = 80,000 + 12,000 = $92,000, profit = 92,000 × 0.10 = $9,200, and bid = $101,200.
Check: 750,000 × 0.40 = 300,000, and 80,000 × 1.15 × 1.10 = 80,000 × 1.265 = 101,200. If the company does less work than planned, the same overhead is spread over fewer dollars and the real rate rises: at $600,000 of labor it is 300,000 ÷ 600,000 = 50%, and jobs priced at 40% leave overhead unrecovered. These are original arithmetic examples, not exam questions. The job costing and overhead guide separates job costs from overhead, and the break-even calculator finds the volume that covers it.
Overhead rate questions
How do you calculate an overhead rate?
Divide the overhead you budget for the year by the direct cost (or direct labor) you plan for the same year. $420,000 of overhead over $3,500,000 of direct cost is 420,000 ÷ 3,500,000 = 12% of direct cost. Check: 3,500,000 × 0.12 = 420,000.
What markup do I need to recover overhead?
On a direct-cost basis the rate is the markup: 12% on every dollar of direct cost. With 8% profit on cost plus overhead, a $180,000 job bids at 180,000 × 1.12 × 1.08 = $217,728, a combined markup of 20.96%.
What if overhead is spread over labor instead?
Divide by planned direct labor and apply the rate to each job's labor. $300,000 over $750,000 of labor is 40%. A job with $30,000 of labor carries 30,000 × 0.40 = $12,000 of overhead, which is a 15% markup on its $80,000 of direct cost.
Where is this on the NASCLA exam?
The Bid Bond course teaches overhead and markup in its Procurement and Contracting Requirements lesson. That is the largest of the twelve subject areas on the NASCLA outline, with 31 of the 115 scored questions.
See the NASCLA exam outline for all twelve subject areas and their question counts.