Contractor Overhead Rate Per Labor Hour Explained

What counts as overhead

Overhead is the cost of running the business that you cannot point to on a single job. Think shop or office rent, general insurance, vehicles that are not tied to one project, phones and software, advertising, bookkeeping and admin help, and licenses.

Direct costs are different. Materials for a job, subcontractors on a job and the wages of the people doing the work are direct. Keep the two groups apart so you do not count one cost twice.

Add up monthly overhead

Here is an invented month: shop rent 1,400 dollars, insurance 900 dollars, shared vehicle costs 650 dollars, phones and software 250 dollars, office and bookkeeping help 700 dollars, advertising 300 dollars, and licenses and sundry items 200 dollars. The total is 4,400 dollars.

Use averages for bills that arrive yearly or in lumps. An insurance premium paid every six months belongs in every month at half the bill divided by six.

Count billable hours, not paid hours

Overhead gets spread over the hours you can actually charge to customers. A person paid for 160 hours a month may bill only 100 of them once travel, quoting, shop time, training, weather, and callbacks are counted. That is 62.5 percent.

In our example four field workers each bill 100 hours, so the business bills 400 hours a month. Be careful here: an optimistic hour count gives a rate that is too low, and you will quietly under-recover overhead on every job.

Overhead per labor hour

Divide the monthly overhead by monthly billable hours. 4,400 divided by 400 is 11.00 dollars of overhead per labor hour.

Watch how sensitive this is. If billable hours were only 320, the rate would be 4,400 divided by 320, or 13.75 dollars. A slow month raises the rate you should have charged. Many owners recompute every quarter and use a longer-run average of hours to keep prices steady.

The burdened labor rate

Burden is the extra cost of an employee beyond the wage: employer payroll taxes, workers compensation insurance, benefits, and paid time off. Burdened labor rate equals base wage times one plus the burden percent.

Take the base wage of 30 dollars an hour and an invented example burden of 25 percent. 30 times 1.25 is 37.50 dollars. Your actual burden comes from your payroll and insurance records and your accountant, not from this page. Keep burden costs here, not in overhead, so they are counted once.

Now add overhead to get the cost of one labor hour: 37.50 plus 11.00 is 48.50 dollars, before any profit.

Pricing a 40 labor hour job with materials

Labor: 40 hours at 37.50 is 1,500 dollars. Overhead: 40 hours at 11.00 is 440 dollars. Materials, at cost: 2,200 dollars (invented). The full cost of the job is 1,500 plus 440 plus 2,200, which is 4,140 dollars.

Say you want a 20 percent margin, meaning profit is 20 percent of the price. Price equals cost divided by one minus the margin: 4,140 divided by 0.80 is 5,175 dollars. Check: profit is 5,175 minus 4,140, which is 1,035 dollars, and 1,035 divided by 5,175 is 20 percent.

One caution on the materials line. If you also add overhead through a markup on materials, do not charge overhead on those same costs again through the hourly rate. Pick one method and use it consistently.

Markup versus margin

Markup is profit as a percent of cost. Margin is profit as a percent of price. They are not the same number. A 20 percent markup on 4,140 dollars gives a price of 4,968 dollars and profit of 828 dollars. But 828 divided by 4,968 is only 16.67 percent margin.

To get a 20 percent margin you need a 25 percent markup: 4,140 times 1.25 is 5,175. If your bank, your accountant or a quote form says 'margin,' make sure you are using the right one.

Likewise, if your billable hours drop to 320, the overhead on the job becomes 550 dollars, cost becomes 4,250 dollars, and the price at 20 percent margin is 5,312.50 dollars. That is 137.50 more than before for the same work, and it is the amount you would have lost by using the old rate.

Keep the rate current

Recalculate every few months, and whenever rent, insurance or headcount changes. A free calculator for the rate itself is at /bookkeeping/contractor-overhead-rate-per-labor-hour-calculator. Then check your finished jobs: compare what a job actually cost with what you estimated, and adjust hours and overhead from there.

Common questions

This guide is general information, not tax, legal or accounting advice. Rules, fees and due dates change; check with the IRS, the NJ Division of Taxation or a licensed professional for your situation.