Overhead Rate: How to Calculate It and Build It Into Your Prices
Overhead is everything it costs to keep the doors open that isn’t tied to a specific job or product: rent, insurance, software, admin wages, the office phone, the accountant. Your overhead rate tells you how big those costs are compared to your sales or your labor. If you don’t know it, it’s very easy to quote prices that cover the job but not the business behind it.
This guide explains overhead rate in plain English, shows two ways to calculate it, and walks through an illustrative example for a small electrical contractor. There’s also a calculator to turn your overhead into an hourly rate.
What Is Overhead?
Overhead is the set of indirect costs you pay to run the business, whether or not you’re doing billable work today.
Typical overhead:
- Rent and utilities for an office or shop
- Insurance and licenses
- Office and admin wages
- Accounting, legal, and bank fees
- Software and phone plans
- Vehicles not tied to one job
- Marketing
- Owner time spent on quoting, scheduling, and admin
Overhead does not include direct costs, such as materials for a specific job or the hours a technician spends on that job. Those belong in cost of goods sold. Most overhead costs are fixed costs. The guide to OPEX (operating expenses) covers how they show up on your books.
Two Ways to Calculate Overhead Rate
1. As a percentage of sales
Overhead rate = Overhead costs ÷ Sales × 100
This shows how many cents of every sales dollar go to overhead. It’s the simplest version and the easiest to compare month to month.
2. As a percentage of direct labor (common in trades and services)
Overhead rate = Overhead costs ÷ Direct labor cost × 100
This tells you how much overhead to add on top of every dollar of labor you put into a job. Some businesses use direct labor hours instead and get an overhead cost per hour.
Worked Example: A Small Electrical Contractor
A contractor with the owner and two electricians has these annual numbers:
| Item | Annual amount |
|---|---|
| Sales | $520,000 |
| Direct labor (electricians’ time on jobs) | $150,000 |
| Materials on jobs | $140,000 |
| Overhead (shop rent, office manager, insurance, vans, software, marketing, owner admin time) | $160,000 |
| Billable labor hours | 4,000 |
Overhead as a share of sales: $160,000 ÷ $520,000 = 30.8%
So about 31 cents of every dollar billed goes to overhead.
Overhead as a share of direct labor: $160,000 ÷ $150,000 = 106.7%
For every $1 of labor on a job, the business needs about $1.07 more to cover overhead.
Overhead per billable hour: $160,000 ÷ 4,000 = $40 an hour
If an electrician costs the business $37.50 an hour in wages, payroll taxes, and benefits ($150,000 ÷ 4,000), the true cost of an hour on the job is $37.50 + $40 = $77.50, before any materials or profit. If the contractor bills $85 an hour, it keeps only $7.50 an hour as profit. If it quotes $75 an hour to win a job, it loses money on every hour, even though $75 is double the electrician’s wage.
Hourly Rate Calculator for Service Businesses
Enter your own pay goal, overhead, and realistic billable hours to see the minimum hourly rate you need to charge.
Service Business Hourly Rate Calculator
Billable hours are hours you can actually charge for, not total hours worked. Add materials and job-specific costs on top. Results are estimates for planning only.
Be honest about billable hours. Most owners spend a big share of their week on quotes, travel, admin, and sales. Twenty-five billable hours out of a 45-hour week is common for solo service providers.
How to Lower Your Overhead Rate
There are two ways: cut overhead, or grow sales and billable hours faster than overhead.
- Review subscriptions and contracts every year. Cancel anything you don’t use.
- Raise billable hours by cutting unpaid travel and admin. Batch jobs by area, use scheduling software, and charge for quotes on complex jobs.
- Price for overhead. Use your overhead rate in every quote, not just materials and labor. The guide on how much to charge for your services walks through this.
- Watch growth costs. A bigger shop or a new office hire raises overhead before it raises sales. Check what it does to your break-even point first.
- Budget it. Overhead is predictable, so it belongs in your business budget.
If you sell products, compare your overhead rate with your gross profit margin. If overhead takes 35% of sales and gross margin is 30%, you lose money on every sale, no matter how many you make.
Frequently Asked Questions
What is the formula for overhead rate?
The simplest version is overhead costs divided by sales, times 100. A business with $160,000 in overhead and $520,000 in sales has an overhead rate of 30.8%. Service businesses often divide by direct labor cost or labor hours instead.
What counts as overhead?
Overhead is any cost of running the business that isn’t tied to a specific job or product, such as rent, insurance, admin wages, software, accounting fees, and marketing. Materials and labor on specific jobs are direct costs, not overhead.
What is a good overhead rate?
It depends on the industry and business model. The real test is whether your gross margin covers overhead and leaves a profit. Track your rate over time and investigate if it creeps up.
How do I include overhead in my prices?
Work out overhead per billable hour or per job, then add it to the direct cost of each quote before adding profit. The hourly rate calculator above does this for service businesses.
Is the owner’s salary overhead?
The part of your time spent on admin, sales, and management is overhead. Time spent doing billable client work is direct labor. Many small business owners simply include their full pay goal in the hourly rate calculation, as the calculator does.
