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The purpose of this Procedure is to establish a method of determining your Overhead Burden Rate to be used in estimating and achieving the targeted profitability. For purposes of accurate job costing this procedure should be used in conjunction with the Procedure titled, Labor Burden Calculation. Both costs must be applied to ensure accurate job costing and estimating

Overhead is defined as all administrative, fixed, and variable expenses not associated with the direct cost of producing revenue. Using Your Company’s financial format, Overhead is defined to include:

(Overhead = Indirect Operating Expenses Other Direct Expenses Not Assigned to a Specific Operation)

Here's the Calculation

The Overhead Rate can be calculated based on either historical financial results or on budgetary figures. Both calculations should be made for comparative purposes. Given the importance of the Overhead Rate in the estimating process, costs should be monitored on a regular basis and the Overhead Rate recalculated at least once per quarter.

The Overhead Rate is a direct relationship between total Overhead and the total of Direct Materials and Direct Labor.

Overhead Rate percentage equals  ( = )  Total Overhead divided by(  / ) Direct Materials, Labor and other Direct Costs

Direct Materials, Labor and other Direct Costs

Here is a sample of how the math looks.

We will consider Direct Materials as anything you purchase to directly accomplish the job you are doing.  If you are a construction company it is all materials, fasteners, supplies, meals, lodging if away from home base.  In other words what ever it takes to complete the project

If you are a beauty salon direct materials are shampoos, water bills, hair care products, clippers etc.

We will consider Direct Labor to include: The labor it takes to accomplish your projects.  All wages, sub contractors, Payroll taxes, Bonuses and Workers Compensation contributions.  This does not include office, sales or ownership wages.

We will consider Overhead to include: all other expenses of your Company. Executive, sales and office wages, supplies, equipment payments, utilities, payroll taxes of the aforementioned employees etc.

Now let's put some numbers to those categories.

Direct Material =      \$ 691,195.00

Direct Labor     =      \$ 748,111.00

Total                   =    \$1,439,306.00

Therefore  \$763,074  divided by  \$1,439,306  =  53%

Your Overhead burden must be added to all job costs. In this Example you must add \$0.53 for every dollar of direct costs. On top of that you still have to add your Net Profit.

Here is an example:

Suppose you have a project with the following costs:

\$10,000       Labor

5,000       Materials

1,000       Sub Contractor’s fees

400       Travel, meals and lodging.

\$16,400      Total Direct Costs

\$ 25,092

x      1.25      Net Profit (at 20% Net Profit)

\$ 31,365      Bid Price

-\$16,400      Actual Direct Cost of Job

\$14,965       Available to pay bills and produce profit

\$16,400 Actual Direct Cost / \$31,365 Bid Price = 0.5229 or about 52%

You need approximately 52% Gross Profit Margin. 52% Gross Profit Margin on a job will produce your desired results.

Conclusion

The Overhead Rate will go down as a percentage (%) of the cost of producing revenue as volume goes up, after the Break Even Point has been achieved. This is because all fixed expenses have been paid.

The Overhead Rate is the second cost of a job (Labor Burden is the first and Net Profit is the last).

It is important that each Sales Person has a Sales Goals based on total Gross Profit Margin.

The Office Manager must keep a running total of Gross Profit produced by each paid job during the year.