Ask a new federal contractor what their bid price is made of and they will usually talk about salaries and hours. Ask an experienced one and they will talk about rates — because in government contracting, the indirect rates you apply to your direct costs can add half as much again to your price, or more. Understanding indirect rates government contracts use is not optional: if you get them wrong, you will either price yourself out of competitions or win work at a price that does not cover your costs.
What Indirect Rates Are
An indirect rate is a percentage you apply to a base of direct costs to recover the costs of running your business that cannot be charged to any single contract. You cannot bill the government directly for your office rent, your accountant, or your employees’ health insurance — but those costs are real, and they have to be recovered through your prices. Indirect rates are the mechanism for doing that. You group your indirect costs into pools, divide each pool by the base it relates to, and the result is a rate you apply to every bid.
There are three pools most small contractors use. The fringe pool covers employee benefits: health insurance, retirement contributions, payroll taxes, paid leave, and similar costs. The overhead pool covers the costs of supporting your direct work: the rent and utilities of the office where your project staff work, the computers and software they use, and the managers who supervise them. The general and administrative (G&A) pool covers the costs of running the company as a whole: executive salaries, legal and accounting fees, business development, and the office costs that are not tied to a specific project.
How the Calculation Works
The calculation itself is simple. Take your fringe pool for the year — say $120,000 in benefits — and divide it by your direct labour base for the year — say $400,000 in direct salaries. The result, 30 percent, is your fringe rate: for every dollar of direct labour on a contract, you add 30 cents for benefits. Do the same for overhead: your overhead pool divided by your direct labour base gives your overhead rate. And for G&A: your G&A pool divided by your total cost input (usually direct labour plus fringe plus overhead) gives your G&A rate.
When you build a bid, you apply the rates in sequence. Direct labour of $100,000 at a 30 percent fringe rate becomes $130,000. Apply a 40 percent overhead rate to that and you get $182,000. Apply a 15 percent G&A rate and you reach $209,300. Add profit on top, and your price for $100,000 of salaries is roughly double the salary cost. That is not padding — it is the real cost of employing people and running a company, and every bidder who survives in this market prices the same way. Our guide on how to price a government contract bid shows how these rates fit into the full price build-up.
Provisional Rates vs Approved Rates
When you start out, you will use provisional rates — rates you calculate yourself from your own financials and use for bidding. As you win cost-reimbursement work, the government (through the Defense Contract Audit Agency, or DCAA, for most agencies) may review and approve your rates. Approved rates are negotiated and then used for billing on cost-type contracts; if your actual rates turn out higher, you may recover the difference later, and if lower, you may owe money back. This is one reason accurate rate calculation matters: a rate that is too high makes your bids uncompetitive, and a rate that is too low means you under-recover your costs for the whole year.
For firm-fixed-price contracts, the government does not normally audit your rates — your price is your price. But your rates still decide whether that price is profitable. A contractor who does not know their own rates is bidding blind, and blind bidders either lose on price or win and lose money. Build your rates from your real books, update them at least annually, and never copy another company’s rates — they reflect that company’s cost structure, not yours.
Mistakes That Cost Money
The most common indirect-rate mistake is the missing pool: a contractor forgets a whole category of cost, usually fringe, and prices labour at salary plus a small margin. The result is a price that looks competitive and a contract that loses money on every hour. The second mistake is the wrong base: applying overhead to total cost instead of to direct labour, or double-counting a cost in two pools. The third is the stale rate: a rate calculated two years ago from a smaller company, still in use after the company has grown and its cost structure has changed. Review your rates every year, and recalculate them when anything material changes — a new office, a new benefits plan, a big hire.
The fourth mistake is treating indirect rates as a markup to maximise. Your rates should recover your actual costs, not generate profit — profit belongs in the fee line, where it is visible and negotiable. A rate that is inflated to hide profit will be caught on any cost-type audit, and it will make your fixed-price bids uncompetitive in the meantime. And the fifth mistake is the simplest: not tracking your costs in the pools at all. If your accounting system cannot separate direct from indirect costs, you cannot calculate a rate — and you cannot win cost-reimbursement work. Set up your chart of accounts with indirect pools from the start, even if you only bid firm-fixed-price work today. It will save you a painful rebuild later.
Getting Started
To build your first set of indirect rates, start with your last twelve months of financials. List every cost, and sort each one into direct labour, fringe, overhead, G&A, or unallowable (some costs, like alcohol or lobbying, can never be charged to the government — learn the list in FAR Part 31). Total each pool, choose the right base, and do the division. Then sanity-check the result: fringe rates for small service firms commonly run 25 to 40 percent, overhead 20 to 60 percent, and G&A 10 to 20 percent. If your numbers are far outside those ranges, find out why before you bid with them — you may have misclassified a cost, or your company may genuinely be structured differently. Either way, know the answer before the price goes in.
Indirect rates are not the most exciting part of government contracting, but they are one of the most important. They are the difference between a price that wins work and keeps you in business, and a price that wins work and puts you out of it. When you build your next price, our guide on how to build a price proposal shows exactly where each rate goes in the cost volume.
Related Guides
Indirect Rates: Build Your Rate Cards Before You Bid
Build your indirect rates once, properly, and keep them current — they are the foundation of every price you submit. Start with your last twelve months of financials, sort each cost into fringe, overhead, or G&A, and check the result against the typical ranges in this guide. Revisit your indirect rates whenever the business changes, because a rate that was right last year can quietly become wrong.
When you are ready to check your indirect rates against the rules, read the cost principles in FAR Part 31, Contract Cost Principles and Procedures, and work through our guide to how to price a government contract bid to see where each rate belongs in the full price build-up. Indirect rates that are built carefully and reviewed every year keep your bids competitive and your contracts profitable.
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