The Importance of Indirect Rate Considerations when Pricing Your Product/Service
By LaTonya Barton, VP IndirectRates.Com
No business will remain in business for long if it does not properly account for all of its costs. Broadly speaking, businesses incur two types of costs during operations. These include costs associated with direct expenditures to the business and costs associated with indirect expenditures to the business.
It is much easier for the business owner to decipher direct expenditures to the business because direct expenditures are the actual costs that are incurred in order to obtain/provide the resources needed to provide the customer with an optimal solution. Direct expenditures for a business may include such things as the hourly rate negotiated with an employee or the cost of a piece of equipment that is being integrated in a solution or the costs of warehouse/factory supplied items obtained for resale.
Not as easy for the business owner to decipher is the proper markup that needs to be applied to those direct expenditures for completing pricing. Indirect expenditures can not be directly accounted for but must be considered when pricing your product or service. Indirect expenditures consider a number of different variable costs including expenditures that are associated with the health and welfare of employees (known as fringe benefits costs), expenditures that support the specific operations closely related to contract activity (known as overhead costs), and management, financial and other expenses related to the general management and administration of the business unit as a whole (known as general and administrative costs).
Not being able to properly calculate the markup associated with indirect expenditures can spell disaster for any business. If the business owner charges too much, the owner runs the risk of overpricing the good or service and losing current or potential customers. If the business owner charges too little, business costs will soon overtake the establishment and it will be forced to shut down.
Because proper indirect rate calculation is important and essential to successful business operations, basic knowledge of indirect cost components is essential for the business owner. One of the keys to calculating those essential indirect rates lies in the business owner's ability to properly classify each expenditure as either a fringe benefits, overhead or general and administrative expense. Once this is accomplished, these indirect expenditures can be segregated into pools of costs that are divided by the appropriate bases to calculate the indirect rates needed to assess the proper markup. Once the mark up in each area has been calculated (fringe benefits, overhead, general and administrative rates), the only remaining consideration is for profit which should be wrapped or loaded in (through multiplication) with the other indirect rates to complete the loaded markup rate. This loaded mark up rate can then be applied to the direct expenditures required for the performance of the solution to complete the pricing.
Although the way indirect rates are calculated hasn't changed over the years, there is a new innovative online tool to assist business owners with this task. One resource of note can be found at www.IndirectRates.com. The site provides definitions of indirect rate terminology and a number of links to federal resources that can help the business owner. The site also provides desktop software or offers a subscription based service that calculates indirect rates for business owners. The software and the site work in combination with several different commercial off the shelf packages (QuickBooks, Peachtree, MYOB, Simply Accounting and spreadsheets) to automatically calculate indirect rates. The summary report even calculates the loaded rate that is to be applied to direct expenditures absent the profit. But it is much quicker and easier for the business owner to take that loaded rate (multiplied with the desired profit) and to apply this to direct expenditures, than it is for the owner to manually perform these indirect rate calculations. For more information on this resource, you should visit www.IndirectRates.com today.