To calculate an overhead rate in construction, add up every indirect cost your company incurred over a full fiscal year, divide that total by an allocation base such as direct labor dollars, and multiply by 100. The result is the percentage you need to add to the direct costs of every bid just to cover the cost of running the business. Most construction firms land somewhere between 10% and 25%, and small firms tend to sit at the higher end because fixed office costs spread across less revenue.
Pull Together Your Indirect Costs
Start in your general ledger and pull every expense that doesn’t tie to a specific job. Direct costs are easy to spot: the lumber on a framing job, the electrician’s hours on-site, the concrete for a foundation pour. Everything else is overhead. Work from a full year of data so seasonal swings and one-off expenses average out.
The indirect costs most construction companies need to capture include:
- Administrative payroll for office managers, estimators, bookkeepers, and anyone who doesn’t bill hours to a project
- Rent or mortgage on your office, yard, or warehouse, plus utilities
- General liability, commercial auto, professional liability, and umbrella insurance
- Legal counsel, accountants, and tax preparation
- Software subscriptions, phones, office supplies, and IT support
- Contractor license renewals and business registration fees
- Fuel, maintenance, and depreciation on company trucks not assigned to a single project
Professional fees are easy to undercount. Your CPA’s bill for preparing the company’s tax return, whether that’s a Form 1120-S for an S-corporation or another business return, is overhead. So are legal fees for contract reviews or employment matters.1Internal Revenue Service. 2025 Instructions for Form 1120-S – Section: Line 20. Other Deductions Read the profit and loss statement line by line rather than working from memory. Small recurring charges like software licenses and cloud storage add up faster than most owners expect, and missing them makes the overhead rate understate reality from the start.
Separate Field Overhead From Home Office Overhead
Construction is unusual because overhead splits into two pools. Home office overhead covers rent on your main office, administrative salaries, and company-wide insurance. Field overhead covers job-site costs that support production but don’t attach to a single deliverable: temporary fencing, portable toilets, site supervision, scaffolding, small tools, and temporary power hookups.
The distinction matters for two reasons. Field overhead is often partially recoverable through contract terms, especially on larger commercial or public jobs where general conditions are a separate line item; home office overhead almost never gets its own line in a bid. And lumping both pools together can produce a single rate so high it looks uncompetitive, while separating them lets you allocate field overhead to the jobs that actually generated those costs and spread home office overhead across your entire volume. Many contractors calculate two rates: one for field overhead applied per project, and one for home office overhead applied as a company-wide percentage.
Pick an Allocation Base
The allocation base is whatever unit of measurement you divide your overhead by. Picking the right one is less about accounting theory and more about matching the base to how the company actually works. Three common options:
- Direct labor costs, meaning total wages paid to field workers across all projects. This works well for labor-intensive trades like framing, drywall, or concrete finishing.
- Direct labor hours, meaning total hours your field crews logged. Useful when wage rates vary widely and you want a per-hour overhead figure.
- Direct machine hours, meaning total hours of heavy equipment operation. Earthwork, demolition, and paving contractors whose costs are driven by equipment often prefer this.
Pull the base from the same fiscal year you used for your indirect costs. Payroll reports give you labor dollars and hours; equipment logs give you machine hours. The base should have a clear cause-and-effect relationship with overhead: more labor hours should mean more overhead consumed, not less. Federal auditors apply the same logic, requiring that the base have a “causal or beneficial relationship” to the costs in the pool.2Defense Contract Audit Agency. Overview of Indirect Costs and Rates
Run the Calculation
With your total indirect costs and allocation base in hand, the math is straightforward:
Overhead Rate = (Total Indirect Costs ÷ Allocation Base) × 100
Suppose your indirect costs for the year totaled $180,000 and your direct labor costs across all projects were $720,000. Dividing $180,000 by $720,000 gives you 0.25. Multiply by 100 and your overhead rate is 25%. For every dollar you pay a field worker, you need to recover an additional 25 cents just to cover the cost of running the business before anyone talks about profit.
If you choose labor hours as your base instead, the result is a dollar figure rather than a percentage. With $180,000 in overhead and 12,000 total field labor hours, you get $15 per labor hour. Either format works. The percentage approach is more common because it scales automatically when you estimate jobs of different sizes.
Apply the Rate to a Bid
Once you have a company-wide overhead rate, applying it to a specific bid is a second, simpler calculation. Estimate the direct costs for the new project (labor, materials, subcontractors, and equipment), then multiply by your overhead rate to find the overhead dollar amount that job needs to carry.
If a remodel has $80,000 in estimated direct costs and your overhead rate is 25%, the overhead charge is $20,000. Add that to the direct costs for a $100,000 baseline. That’s your break-even number before any profit markup. Every project that ships without this overhead charge forces the rest of your work to subsidize it, and eventually the math catches up.
Markup vs. Profit Margin
This is where a lot of contractors trip up. Markup and profit margin are not the same number, and confusing them will leave money on the table. Markup is a percentage of your costs. Margin is a percentage of the selling price. A 20% markup on a $100,000 cost base gives you a $120,000 selling price, but your profit margin on that sale is only 16.7% ($20,000 ÷ $120,000).
The formulas:
- Selling price using markup: Cost × (1 + Markup %)
- Selling price using margin: Cost ÷ (1 − Margin %)
For a true 20% profit margin, price the job at $100,000 ÷ (1 − 0.20) = $125,000, which works out to a 25% markup. The gap between markup and margin widens as the percentages climb. Owners who set a target margin but apply it as a markup consistently underprice their work.
Reconcile at Year-End and Adjust as the Business Changes
Your overhead rate is an estimate built on last year’s numbers. Actual indirect costs during the current year will almost certainly differ. If you applied less overhead to jobs than you actually spent, that shortfall means your bids were too low and your profit took the hit. If you applied more than you spent, your bids were slightly fat and may have cost you work.
At year-end, reconcile the difference. The simplest method is to close the variance directly into cost of goods sold on your income statement. A more precise approach allocates the variance proportionally across work in progress, finished jobs, and cost of goods sold based on how much overhead each category absorbed during the year. Either method is acceptable. Whichever you use, the reconciliation tells you whether next year’s rate needs adjusting.
Between reconciliations, compare your applied overhead to your actual indirect costs quarterly. A rate that was accurate in January can be three to five points off by September if the business changed meaningfully. Immediate recalculation is warranted for a significant office hire or layoff, a move to a larger or smaller facility, adding or dropping a major insurance policy, or a sharp change in project volume. Any of these can swing your rate by several percentage points, and the sooner you update, the less variance you clean up later.
Sanity-Check Against Industry Benchmarks
Your own number matters more than an industry average, but benchmarks are useful as a gut check. Data from the Construction Financial Management Association suggests these ranges as a percentage of revenue:
- Heavy highway contractors: 10%–15%
- Industrial contractors: 12%–18%
- Commercial and institutional general contractors: 15%–20%
- Specialty trade contractors (electrical, plumbing, HVAC): 18%–25%
- Small firms under $50 million in annual revenue: 20%–25%
Small companies run higher rates because the same fixed costs (office rent, bookkeeper salary, insurance minimums) get spread across fewer revenue dollars. A 22% overhead rate at a $5 million firm can be perfectly healthy as long as bids reflect it. The danger is assuming the industry average is 10% and pricing accordingly without ever calculating the real number.
Federal Contracts: Costs You Can’t Include
If you bid on federal work, the overhead pool you charge to the government is not the same pool you use for private-sector bids. The Federal Acquisition Regulation flags several categories as unallowable, meaning the government will not reimburse them regardless of how legitimate they are as business expenses:3Acquisition.GOV. FAR Part 31 – Contract Cost Principles and Procedures
- Entertainment costs, including tickets, meals at social events, club memberships, and related transportation or lodging
- Contributions and donations of cash, property, or services
- Lobbying and political activity
- Fines and penalties from violating any law, plus costs related to mischarging on government contracts
- Alcoholic beverages
- Bad debts and collection costs
- Interest expense, with narrow exceptions
These costs still belong in the overhead rate you use for private-sector bids because they’re real expenses your company bears. But you need a separate, scrubbed pool for government work. Federal auditors will disallow any of these costs they find in your indirect rate, and the resulting adjustment can turn a profitable contract into a loss. Every cost in the pool must be reasonable, properly allocable, and treated consistently across all your contracts.2Defense Contract Audit Agency. Overview of Indirect Costs and Rates A contracting officer may also negotiate a ceiling on your indirect cost rate, particularly if the company is new or has a history of rapidly increasing rates.4Acquisition.GOV. FAR Subpart 42.7 – Indirect Cost Rates
When You Have to Capitalize Overhead Instead of Deducting It
Most contractors treat overhead as a current-year expense, and for income tax purposes it usually is. But if your company builds an asset for its own use (a storage building, a new shop, custom equipment), Section 263A of the Internal Revenue Code requires you to capitalize a share of your indirect costs into the cost of that asset rather than deducting them immediately. These are the uniform capitalization, or UNICAP, rules.
The costs that must be capitalized to a self-constructed asset mirror many of the same items in your overhead pool: indirect labor, officer compensation, rent, depreciation on equipment used in production, utilities, insurance, repairs, and a share of administrative service costs like accounting and purchasing.5eCFR. 26 CFR 1.263A-1 – Uniform Capitalization of Costs You allocate them using a reasonable method, such as a burden rate or specific identification, and the allocated portion gets added to the asset’s depreciable basis instead of hitting the income statement as a current deduction.
There is a small-business exemption. If your company’s average annual gross receipts over the prior three tax years fall below the inflation-adjusted threshold, you’re exempt from UNICAP entirely. For tax years beginning in 2025, that threshold is $31 million.6Internal Revenue Service. Rev. Proc. 2024-40 The IRS publishes an updated figure each year, so check the current revenue procedure. Most residential and small commercial contractors sit well below this line, but growing firms that cross it need to adjust their accounting immediately or risk a costly correction later.