The overhead rate is a component of net multiplier. Overhead expenses are all costs not chargeable to specific projects such as rent, utilities and insurance. The overhead rate indicates the relationship of all indirect expense to each dollar of direct labor. The overhead rate is used to estimate the overhead expense for fixed-fee projects. The overhead rate is obtained by dividing indirect (overhead) expense by direct labor. An overhead rate of 150% means that for each $1.00 of direct labor budgeted for a project; $1.50 needs to be budgeted for overhead costs. If the total direct labor budget for a project is $1,000, then the overhead budget would be $1,500 ($1,000 x 150%). Indirect labor is usually the greatest line-item overhead expense.
The most effective way to lower the overhead rate is to charge all project related labor and expense to the appropriate project. If a project’s expense is charged to overhead, then all projects share in the cost of that project thus overstating the profit on that project and understating the profit on all other projects. Overhead expense is usually allocated to a project in the same proportion as direct labor charged to that project. Another method of overhead allocation is based on revenue. Most firms use Direct Labor rather than Revenue to allocate overhead to projects.