Indirect Rates - "What's a Good Indirect Rate?"
CFO Forecasting – Part II
In a prior blog in our series on CFO's for Government Contractors, we emphasized the importance the CFO’s role in establishing job cost accounting and developing an indirect rate structure that’s suitable for a particular business. Once the mechanics of an adequate government contract accounting system is established, we’re often asked…
What’s a good indirect rate?
The process of establishing a “good” indirect rate starts with a budget process. Budgeting should be done covering an annual fiscal period and on an accrual basis. Identify all current and potential jobs. You may have to apply subjective reasoning to include new work you hope to land. Of course, you can forecast rates using any level of confidence for including projects into a budget. Build a budget model that can reliably and efficiently calculate indirect rates using your desired structure (i.e. one-rate, two rate, or any variation).
Include administrative fixed costs, such as rent and utilities. Include other administrative costs, such as fringe costs and all other costs that contribute to the business. Be especially mindful to include those allowable costs that help propel your business, such as marketing and bid and proposal.
Labor costs and the fringe costs that go along with it have dramatic effect on your indirect rates. Pay special attention to the allocation of labor between direct projects and indirect work. Paid time off (PTO) is an element of fringe, so it’s helpful to have a consistent PTO plan.
Establishing a target
Once all cost data is in your indirect rate model, compare them to others of your size and complexity, within your industry, and targeting similar government agencies for work. Your approach to indirect rates may change depending on those variables along with your competitive environment.
Where can you find comparable indirect rates? If you are a prime contractor, you can always ask your government counterpart if you’re in an acceptable range. You would likely hear from them if you weren’t. The same goes if you are a subcontractor to a prime.
If you know of a competitor having a GSA contract, the agreement with GSA is public and with some sleuthing you can at least get an idea of their indirect rates.
In the end, a savvy CFO will choose an indirect rate level that’s competitive but still allows your business to grow.
Measuring Actual Rates
Once a comfortable indirect rate is established, CFO’s make sure to record actual costs accurately and calculate indirect rates at least quarterly for comparison with the annual budget. Where actual rates come in lower than projections, this gives the CFO an opportunity to advise executives where additional spending would benefit the growth of the business. CFO’s can also either put the brakes on spending if rates run higher than expected, or be willing to realize slimmer profits.
As a government contracting business grows into more sophisticated types of contracts, the variety of indirect rates multiply. During a proposal phase, you may be asked to provide your indirect rate calculations as a basis of negotiations. Once you’ve landed a job, if it’s cost-reimbursable, you’ll be required to submit and possibly negotiate a provisional billing rate proposal. This is a formal agreement with the government that allows a firm to bill at a consistent indirect rate for an annual period, provided actual rates don’t “substantially” deviate from these planned rates.
Final indirect rates are negotiated with the government for cost-plus type contracts. CFOs and their accounting staff must report final indirect rates in the form of an Incurred Cost Proposal as stipulated in federal regulations.
Government agencies, prime contractors, and consultants all provide models for calculating indirect rates. Beware that just because you’ve gained access to such a model, it may not have the ability to reflect your specific indirect rate structure and allocation methods (see our Indirect Rate Models white paper below). Even worse, many of these models attempt to address all indirect rate scenarios, causing confusion for the novice CFO. A CFO must understand what methods they are using to both accumulate costs and allocate costs when calculating indirect rates.
Managing indirect rates for a small business can be especially challenging for a CFO. Many more contracts than before are partially funded, make projections of future work much less certain. Many contracting offices may attempt to “cap” indirect rates at arbitrary levels. CFOs in this environment do well to understand the basic funding mechanisms government contracts and identify potential risks to indirect rates.
-Dave Donley, ReliAscent
CFO and Indirect Rates Resources
If you would like to learn more about how ReliAscent's outsourced CFO experts can help your business, please visit our Outsourced CFO Services page, and complete the form on the left. We also have a number of useful white papers and videos:
- "Indirect Rate Models - Are You Using the Right One?" - white paper
- "Top 15 Reasons You Need an Outsourced CFO" - white paper
- Outsourced CFO Services - YouTube Video