Many companies, large and small, struggle with the amount to add to their estimated direct costs when bidding on projects to cover their indirect costs and profit.

Having accurate forecasted burden rates will allow the company to determine how to price a future project to cover its direct costs, indirect costs, and profit.  These rates will also allow the company to see if they will lose money or not meet their targeted net profit on a project.  This is good to know when the customer (or completion) is dictating the total price of the project.  It is much better to know the project will be unsuccessful during the bid process rather than once the project is under way.  Companies call these bid/no bid meetings.  I had a client tell me that some of the best business they do is business they don't do. 

The burden rates show the relationship of the company's indirect costs to the company's direct costs on a percentage basis.   They can be based on historical or forecasted data.

An example of an indirect rate would be the "Fringe Rate".  When a new employee is hired, the cost to the company is not the just the employee's wages.  It's the employee's wages plus the statutory and non-statutory fringe benefits i.e. the company's share of the FICA, FUTA, SUTA, health insurance, etc.  Knowing the percentage (fringe rate) that needs to be added to the wage amount will give the company the actual cash impact on the company for hiring a new employee.

The burden rate is the dollar amount of burden (i.e., fringe benefits) that is applied to one dollar of wages. For example, if the annual benefits and payroll taxes associated with an individual is $20,000 and his wages are $80,000, then the burden rate is $0.25 per $1.00 of wages (a fringe rate of 25%).

The formula for calculating labor burden is:  

Labor burden cost / Payroll cost

It is particularly important to include the burden rate when reporting on the full cost of labor, because some benefit packages can increase the total cost of labor to a point even 40% greater than the cost that is initially indicated in the payroll records. This information is useful when deciding whether to outsource positions to consultants.  The burden rate concept is especially worthwhile in situations where the bulk of a company's business comes from directly billable hours, where you need to track profits by person.

There are numerous other burden rates that companies develop to arrive at the appropriate absorption of their indirect costs.  The burden rate(s) should be based on the most accurate cost/benefit relationships available.  Some rates are based on labor dollars (as above) and some are based on square footage, which is a more accurate way to arrive at an indirect rate for facilities costs such as rent, heat, light, and power.  Manufacturing overhead rates can be based on labor dollars or machine hours.

Regardless of the method used, accurate indirect rates are valuable tools for companies large and small.  Once the cost benefit relationships are established and the rate models are designed and implemented the company can apply them to their historical costs to arrive at their base line burden rates.  These rate models can also be applied to the company's forecast to arrive at the forecasted indirect rates.  The forecasted burden rates should be more accurate than the historical rates when bidding jobs because the period of performance will occur during the forecast period not the prior periods.

Each company should design their own burden rates to absorb their indirect costs based on the most accurate cost benefit relationships in the company.  Companies doing business with the Defense Department must comply with strict definitions of Fringe, Overhead, and General and Administrative costs outlined in the Federal Acquisition Regulations when developing their indirect rates.  However, even defense contractors may develop numerous indirect rates based on their individual company's cost structure.    

We at Nperspective are continually helping companies develop and implement burden rates.  Please let us know if we can help you do some of the best business you ever do.  Even if it is the business you don't do.