Construction Overhead Rate for Public Bids: Get It Right
Here is a scene that plays out in a lot of contractor offices after a first public award. The contract is signed, the work is going well, and then the first change order comes in. The contracting officer asks for a cost breakdown, including how the overhead percentage was calculated. The estimator looks at the controller. The controller says the 15 percent "is what we always use." Nobody can show where it came from.
Your construction overhead rate is one of the most important numbers in your business, and on public work it gets examined. Bid it too low and you subsidize every job. Bid it too high and you lose to competitors. Carry costs in it that the government will not pay for, and you can lose them on every change order. This guide walks through how to build a rate you can defend.
Table of Contents
What a Construction Overhead Rate Is
Every contractor has two kinds of costs.
Direct costs belong to a specific job: labor, materials, equipment and subcontracts for that project.
Indirect costs keep the company running and benefit more than one job: office rent, accounting staff, estimating, insurance not charged to a job, software, and executive time.
The Federal Acquisition Regulation (FAR) describes indirect costs in section 31.203 as those remaining to be allocated after direct costs are charged. It also requires the contractor to group indirect costs logically and pick an allocation base that spreads them according to the benefit each job receives.
Your overhead rate is simply your indirect cost pool divided by that base. If your annual indirect costs are $600,000 and your base is $5,000,000 of direct job cost, your rate is 12 percent. Every dollar of direct cost on a bid then carries 12 cents of overhead.
Job overhead versus home office overhead
Keep project-level general conditions, like a superintendent or a site trailer on a specific job, in direct costs for that job. Home office overhead is what goes into the rate. Mixing the two is one of the most common reasons a rate cannot be explained.
Why Public Work Raises the Stakes
On a fixed-price public bid, nobody audits how you got to your total. But the rate matters again the moment the contract changes. FAR 31.105, which covers construction and architect-engineer contracts, says the cost principles in Subpart 31.2 are used to price contract modifications when cost analysis is performed. In practice, that means your change order pricing, claims and termination settlements are all measured against the federal cost rules.
What a cost review looks like in practice
Picture a contracting officer reviewing your proposal for a change order. They will ask for the direct costs with backup, then ask how you got from direct cost to the total: overhead, bond, insurance and profit. If your overhead percentage traces back to a documented pool and base from your books, the discussion is short. If it is a round number with no support, expect the government's cost analyst to propose their own figure, and expect that figure to be lower. The same thing happens in a claim, where the burden is on you to show your costs.
That is why the rate is a back-office decision, not an estimating one. The estimator applies it. The controller owns it, documents it and updates it.
State and local agencies often follow their own procurement codes and may set markup limits in the contract itself, so always read the changes clause before you bid. Our federal change order playbook covers the notice and pricing steps in more detail.
Allowable and Unallowable Costs Under FAR Part 31
Under FAR 31.201-2, a cost is allowable only if it is reasonable, allocable, consistent with the applicable accounting standards, consistent with the contract terms, and not limited by Subpart 31.2. Several common overhead items are specifically unallowable.
Cost | FAR section | Treatment |
|---|---|---|
Entertainment (amusement, social activities and related costs) | 31.205-14 | Unallowable |
Interest on borrowings and costs of financing | 31.205-20 | Unallowable, with narrow exceptions |
Bad debts from uncollectible receivables | 31.205-3 | Unallowable |
Fines and penalties for violating laws or regulations | 31.205-15 | Unallowable, except as the contract or contracting officer requires |
Contributions and donations | 31.205-8 | Unallowable, with limited exceptions |
Lobbying and political activity | 31.205-22 | Unallowable, with listed exceptions |
None of this stops you from spending money on these things. It means they should sit in a separate account so they are not buried inside the rate you present to a contracting officer. Our guide to why bid preparation costs matter covers another overhead category that has its own FAR rule.
Equipment is handled separately
FAR 31.105(d) says actual cost data should be used for equipment ownership and operating costs when it can be determined, and that agencies may otherwise specify a schedule of predetermined rates. It also notes those schedules generally do not include labor, mobilization, demobilization, overhead or profit. Keep equipment out of your home office pool.
How to Build Your Overhead Rate Step by Step
Start from last year's actual books. Use the general ledger, not a budget. Once your year-end numbers close, rebuild the rate from them.
Separate direct from indirect. Walk every account and every salaried person. A PM who spends 80 percent of their time on one job is mostly direct.
Pull out the unallowable costs. Move them into their own accounts so they never enter the pool.
Choose your allocation base. Total direct cost is common for general contractors. Direct labor can make sense for self-performing trades. Pick one and apply it consistently.
Calculate the rate. Indirect pool divided by base.
Document it. One page that shows the pool, the base, the exclusions and the period. That page is what you hand a contracting officer.
Apply it the same way on every bid. Our guide to competitive pricing for federal bids shows where the rate fits in the full price.
Test it against your growth plan
If you expect revenue to grow next year, your fixed overhead spreads over a bigger base and the rate drops. If you are adding an estimator and a controller, it rises. Run both scenarios before you commit to a number for the year.
Common Overhead Rate Mistakes
Using a rule of thumb. A percentage from a past employer or a seminar is not your rate.
Double counting. Putting a superintendent in general conditions and also in the overhead pool.
Leaving unallowable costs in the pool. They come out at the first cost review anyway, and your credibility goes with them.
Never updating it. A rate built three years ago on a smaller company is wrong in both directions.
Applying it inconsistently. One rate on bids, another on change orders, and a third in claims is hard to defend.
Keeping the Rate Current
Recalculate the rate at least once a year from closed books, and check it at midyear against actual spending. Keep a simple history so you can show how the rate moved and why. When you price subcontractor work on cost-type changes, the same discipline applies to their numbers, which our article on estimating subcontractor quotes for FAR 15.404-3 covers.
Let AI do the sorting
Coding a year of general ledger detail into direct, indirect and unallowable buckets is tedious. AI tools are good at a first pass: flagging likely entertainment, interest and donation entries, and grouping accounts for your review. Your controller still makes the final call, but the review takes hours instead of days.
What I've Seen Inside Contractor Shops
After 30+ years in construction operations, I can say the contractors who do well on public work are rarely the cheapest. They are the ones who know their numbers. When a contracting officer asks how a markup was built, they hand over one page and the conversation moves on. When a contractor cannot explain it, every change order turns into a negotiation over the rate instead of the work.
From the office side of construction, the fix is almost always the same: separate the accounts, rebuild the rate from real books, and write it down. It is not glamorous work, and it is the kind of thing that only gets done when someone puts it on the calendar. Year-end is the natural time.
Get Help Pricing Public Work
FederalIQ by R.CS helps contractors pursuing federal, state and local work build defensible pricing, compliant proposals and the back-office processes behind them. Contact us at federaliq.byrcs.io/contact-us or call (719) 838-5551.
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FAQ
What is a construction overhead rate?
It is your indirect cost pool, the costs that keep the company running and benefit more than one job, divided by an allocation base such as total direct job cost. The result is the percentage of overhead added to direct costs in a bid.
Which overhead costs are unallowable on federal contracts?
Under FAR Subpart 31.2, entertainment, interest and financing costs, bad debts, most fines and penalties, contributions and donations, and lobbying costs are unallowable, with limited exceptions.
Does my overhead rate matter on a fixed-price public bid?
Yes. FAR 31.105 applies the Subpart 31.2 cost principles to pricing contract modifications when cost analysis is performed, so change orders, claims and terminations are measured against those rules.
What allocation base should a contractor use?
Total direct cost is common for general contractors, and direct labor can make sense for self-performing trades. Choose one that reflects how jobs benefit from overhead and apply it consistently.
How often should I update my overhead rate?
Recalculate it at least once a year from closed books and check it at midyear against actual spending, especially if revenue or staffing is changing.
