Understanding Indirect Rates:
Contract Pricing

Part 2 of 3

By Robert Smith, CEO of ICAT Systems

Indirect Rates can be one of the more confusing concepts for government contractors to grasp. There are nuances with respect to how Indirect Rates are used in Cost Accounting, Pricing, and Billing. When understood comprehensively, government contractors are equipped to better manage contracts and the business as a whole. I'll explain the role of Indirect Rates in each of these areas in this three part series.

Factoring Indirect Rates into Contract Pricing

Contract Pricing is all about recovering costs and generating fee. Contracts must be priced so that funding is provided to recover the direct costs of performing the contract, the indirect costs to be allocated to the contract, and if all goes according to plan, make a profit (which reminds me of one of my favorite lines from The Godfather).

Indirect Rates, with respect to Pricing, are metrics used to estimate the indirect costs that will be allocated to the contract during the period of performance. The Indirect Rates are applied to the proposed direct costs so that the Contract Pricing will be sufficient to recover the proposed contract’s share of the contractor’s indirect cost burden.

Historical Indirect Rates vs. Prospective Indirect Rates

It is important to note the distinction between Historical Indirect Rates and Prospective Indirect Rates. Historical Indirect Rates measure activity that has already occurred. They are calculated based on accounting data that has been recorded in the contractor’s books.

Prospective Indirect Rates are used to estimate future activity. They are calculated based on budgeting future business projections.

It is Prospective Indirect Rates, rather than Historical Indirect Rates, that should be used for Contract Pricing.

Because Prospective Indirect Rates are used in Contract Pricing, unanticipated events can easily occur and have a significant effect on a contractor’s Indirect Rates and bottom line. To mitigate against this, a contractor must maintain a well-managed budgeting function. With a detailed budget, a contractor is better equipped to calculate Prospective Indirect Rates for Contract Pricing purposes.

Read the Full 3 Part Series on Indirect Rates in Government Contracting
ICAT Streamlines Indirect Rate Calculation for QuickBooks® Users