As government contractors, understanding indirect rates can significantly impact your business operations and competitive edge in winning new contracts.
In response to requests for proposals, also known as RFPs, contractors must project the direct costs of executing the contract, subsequently burdening these costs with indirect rates. Thus, it’s essential to comprehend these rates, learn how to calculate indirect costs, and ultimately adopt the most suitable indirect rate structure for your own operations and prospective bidding opportunities.
Keep reading to learn more about why indirect rates are so important in government contracting, and how to determine an indirect rate structure for your own proposals.
The Importance of Indirect Rates
For government contractors, understanding the role and application of indirect rates can significantly shape the way they conduct their business and bid on contracts. These rates are integral when responding to RFPs, because contractors must project the direct costs of executing the contract, which includes their indirect rates
Decoding Indirect Rates
Contractors use indirect rate calculation to allocate indirect costs to final cost goals, typically formed as ratios of a cost pool to an allocation base.
An indirect rate structure is a pricing system that government contractors use to determine the comprehensive cost of labor. This time-tested pricing model assists contractors in accurately identifying and reporting total contract costs and lends significant support during pricing computations when bidding on government contracts.
These rate structures cover all indirect rates a contractor uses to allocate the total costs incurred to the final cost objectives. Structures can range from simple, incorporating a single indirect cost pool and rate, to highly complex ones that include multiple indirect cost pools and rates and potentially involving intermediate cost pools.
Properly Selecting The Ideal Rate Structure
The Federal Acquisition Regulation, or FAR, offers valuable guidance for calculating indirect rates and contemplating pools and bases.
It also allows for flexibility, recognizing that businesses differ in their operations. Consequently, smaller contractors may prefer a straightforward rate structure, which is easy to maintain and calculate. On the other hand, larger contractors with more complex operations might require a more sophisticated indirect rate structure.
Intermediate cost pools, such as a facilities pool that gathers all costs associated with maintaining a facility and distributes these costs to final cost objectives or other indirect cost pools, can be incorporated for optimal indirect cost allocation.
Key Considerations When Choosing Your Rate Structure
When determining indirect rate calculation and finding the most suitable indirect rate structure, contractors should consider the following factors:
- Primary Cost Drivers: Understanding the key cost drivers, whether it’s employee labor, materials, or subcontract costs, will significantly impact your indirect labor costs and rate structures.
- Labor Classification: Are different labor classes with distinct fringe benefit packages employed? If so, creating multiple fringe pools may be required.
- Contract Types: Does your company perform different types of contracts, each with unique cost drivers?
- Locations and Shared Services: For companies with multiple sites or a home office providing shared services, treating the shared services as an intermediate cost pool could be advantageous.
- Accounting Team Capabilities: The ability of your accounting team to handle complex rate structures is essential. While a robust team might manage complex structures, smaller contractors could find these overwhelming.
- Pricing Team Strength: A competent pricing team might be able to effectively predict the impact of new contracts on future indirect rates.
Leveraging Indirect Rates for Maximum Benefits
Effectively managing indirect rates can be a decisive factor in maintaining profitability and winning new contracts.
A keen understanding of these rates enables contractors to formulate competitive bids, allocate costs appropriately, and ensure compliance with government regulations. As such, the role of indirect rates cannot be overstated in government contract accounting.
Understanding Indirect Rates for Success in Contracting
Determining the ideal indirect rate structure necessitates careful consideration of various factors. When making this decision, each contractor should carefully consider their operations, upcoming bidding opportunities, and internal capabilities, while understanding how to calculate indirect costs.
The optimal structure will neither overburden the accounting team nor compromise the accurate representation of a contractor’s operations and overall bidding opportunities. Government contractors will be far better equipped to compete effectively in the marketplace by understanding and appropriately leveraging indirect rates, ensuring that they maintain profitability while delivering on their contractual obligations.
At Diener & Associates, our team of experienced CPAs stands ready to assist and provide expert guidance in this critical area of government contract accounting. Contact Diener & Associates today and see how our services can help you through potential government contracting challenges.