Overhead Rate: worked example
| Total overhead | $120,000 |
|---|---|
| Direct labor cost | $200,000 |
| Direct labor hours | 8,000 |
| Overhead rate on labor cost | 60.0% |
| Overhead per labor hour | $15 |
Overhead Rate: formula
Common error: Using last year's rate without checking it. If overhead grows faster than labor, the old rate leaves each job under-charged.
Total overhead is the period's indirect operating cost. It includes rent, utilities and administrative salaries. Insurance and equipment can also be indirect costs.
A cost tied to one job belongs separately. Direct labor cost and direct labor hours are the labor that goes straight into products or billable work. Take overhead from the income statement and be consistent about what counts as direct: an item cannot be in both.
Overhead Rate: changing Total overhead
| Total overhead | Overhead rate on labor cost | Overhead per labor hour |
|---|---|---|
| $96,000 | 48.0% | $12 |
| $108,000 | 54.0% | $14 |
| $120,000 (example) | 60.0% | $15 |
| $132,000 | 66.0% | $17 |
| $144,000 | 72.0% | $18 |
Overhead Rate: compare input ranges
| Input | Tested from | To | Overhead rate on labor cost: low input | Overhead rate on labor cost: high input | Swing |
|---|---|---|---|---|---|
| Total overhead | $108,000 | $132,000 | 54.0% | 66.0% | 12.0% (20%) |
| Direct labor cost | $180,000 | $220,000 | 66.7% | 54.5% | 12.1% (20%) |
| Direct labor hours | 7,200 | 8,800 | 60.0% | 60.0% | 0.000% |
Overhead Rate: individual input comparisons
| Input | Value | Overhead rate on labor cost | Overhead per labor hour |
|---|---|---|---|
| Total overhead | $96,000 | 48.0% | $12 |
| $108,000 | 54.0% | $14 | |
| $120,000 | 60.0% | $15 | |
| $132,000 | 66.0% | $17 | |
| $144,000 | 72.0% | $18 | |
| Direct labor cost | $160,000 | 75.0% | $15 |
| $180,000 | 66.7% | $15 | |
| $200,000 | 60.0% | $15 | |
| $220,000 | 54.5% | $15 | |
| $240,000 | 50.0% | $15 | |
| Direct labor hours | 6,400 | 60.0% | $19 |
| 7,200 | 60.0% | $17 | |
| 8,000 | 60.0% | $15 | |
| 8,800 | 60.0% | $14 | |
| 9,600 | 60.0% | $13 |
Overhead Rate: combined input changes
| Total overhead / Direct labor cost | $160,000 | $200,000 | $240,000 |
|---|---|---|---|
| $96,000 | 60.0% | 48.0% | 40.0% |
| $108,000 | 67.5% | 54.0% | 45.0% |
| $120,000 | 75.0% | 60.0% | 50.0% |
| $132,000 | 82.5% | 66.0% | 55.0% |
| $144,000 | 90.0% | 72.0% | 60.0% |
Overhead Rate: which assumptions move the result?
Overhead Rate: values and definitions
| Quantity and definition | Value used |
|---|---|
| Total overhead | $120,000 |
| Direct labor cost | $200,000 |
| Direct labor hours | 8,000 |
| Overhead rate on labor cost | 60.0% |
| Overhead per labor hour | $15 |
Overhead Rate: half and double Total overhead
| Total overhead | Overhead rate on labor cost |
|---|---|
| $60,000 | 30.0% |
| $120,000 | 60.0% |
| $240,000 | 120.0% |
A single rate is an average, and it can misprice jobs that use more machinery or space than labor. Activity-based costing uses several rates. The rate changes with volume: in a slow month overhead per hour rises.
Use a full year of data to avoid seasonal swings, and revisit at least annually.
Business Finance calculators: Gross Profit and Margin Calculator, Markup Calculator, Business Break-Even Calculator, Profit Margin Calculator, Burn Rate & Runway Calculator, ROAS Calculator.
An assumed $120,000 overhead pool spread over 10,000 machine hours gives $12 per machine hour, while spreading the same pool over 8,000 labor hours gives $15 per labor hour; five measured hours therefore allocate $60 under the first basis and $75 under the second. The cost driver changes the allocation. Under the separate 60%-of-labor-cost example, $1,000 of direct labor carries $600 of overhead.
Whether a quote covers total costs depends on its price and all included costs; omitting an overhead line alone does not establish a loss on every job.
Pick the base that fits the business. Labor cost suits a labor-heavy trade, and machine hours suit a shop where equipment drives the cost.
Use the result to set prices with the target price and markup calculators, and check volume with the break-even and profit goal pages. The employee cost calculator shows the loaded labor cost, and the contribution margin page separates fixed from variable costs. Reducing overhead lowers every job's cost.
What is an overhead rate?
A way of assigning indirect costs to jobs or products, usually as a percentage of direct labor cost or an amount per direct labor hour.
Should I use labor cost or labor hours?
Use hours when wage rates differ widely across workers, so the allocation reflects time. Use cost when pay is similar or when overhead follows the payroll.
Why does my overhead rate change?
Overhead and direct labor both change from period to period. When work slows and overhead stays the same, the rate per hour rises.