# How to Calculate a True Overhead Rate Without the Accountant Hand-Wave **By Dan Cumberland** · Published May 19, 2026 · Categories: AI Strategy > Most architecture firms need two overhead rates: one for internal pricing decisions, and— if they do public-sector work— one calculated under FAR Part 31 for... ## The Two Overhead Rates Most Firms Don't Know They Need Most architecture firms need two overhead rates: one for internal pricing decisions, and— if they do public\-sector work— one calculated under FAR Part 31 for government billing\. The two numbers are usually different\. Using the wrong one leads to underpriced proposals or audit problems\. The internal\-pricing rate includes every real cost of running the firm\. The FAR rate excludes specific "unallowable" costs under 48 CFR Part 31\. A third version, the rate your outside CPA prepares for GAAP and IRS purposes, often shares data with the first but gets framed for reporting, not pricing\. ```html-table
RatePurposeWho needs it
Operator's ratePricing work, setting billing rates, fee proposalsEvery firm
Reporting rateTax return, GAAP financials, lender packagesEvery firm (typically prepared by outside CPA)
FAR rateGovernment contracts over $500K17Firms with U.S. public-sector work
``` Your accountant isn't producing the wrong number\. They're producing a number for a different purpose\. The rest of this article is about the first row\. Before we can audit either rate, we need the formula and what goes on each side of it\. ## The Formula \(And What Actually Goes On Each Side\) **Overhead Rate = Total Indirect Expenses ÷ Total Direct Labor**[1](/blog/blog-overhead-architecture#ref-1) Both sides are in dollars\. The result is unitless\. A firm with $1\.8M of indirect expenses against $1\.2M of direct labor has a 1\.5 overhead rate, or 150%[12](/blog/blog-overhead-architecture#ref-12)\. Direct labor, per the AIA, is the "actual wages paid to people for all hours spent working on a client project\."[8](/blog/blog-overhead-architecture#ref-8) Everything else worked\-time\-wise is indirect labor— and most calculation errors live in the gap between them\. Indirect expense has three components[7](/blog/blog-overhead-architecture#ref-7): - **Indirect labor** — administrative staff, marketing, principal non\-billable time, PTO - **Payroll\-related expenses** — 15–20% of total wages, covering employer FICA, unemployment, healthcare, retirement contributions - **Other non\-labor indirect costs** — rent, software, insurance, facility costs, professional registrations Three rules keep the math honest\. Both sides in dollars\. Not hours\. Not a percentage of revenue\. An overhead rate of 1\.5 means the firm spends $1\.50 of indirect cost for every $1\.00 of direct labor it pays\. To anchor: an 18\-person firm with $1\.2M direct labor and $1\.8M indirect expenses produces a 1\.5 overhead rate, which turns a designer earning $50/hour into a $125/hour fully burdened cost before any profit[12](/blog/blog-overhead-architecture#ref-12)\. The formula is simple\. The classification decisions behind it are where firms lose 10–30 basis points of margin\. ## The Five Decisions Where the Hand\-Wave Hides Five classification decisions determine whether your overhead rate is defensible or fiction: how you handle principal non\-billable time, owner draws, marketing salaries, payroll burden, and reimbursable expenses\. Get any one wrong and the number you price against is wrong with it\. Accounting software typically lumps payroll into a single account, so direct and indirect labor never get split unless someone manually disaggregates them[16](/blog/blog-overhead-architecture#ref-16)\. That single shortcut is the source of most of what follows\. ### 1\. Principal non\-billable time Principal salaries should be split between direct and indirect labor based on actual utilization\. The Monograph utilization target for principals is 40–50%[9](/blog/blog-overhead-architecture#ref-9)\. Treating the entire principal salary as direct labor understates overhead by the share of non\-billable hours\. Treating it entirely as indirect overstates overhead and inflates the break\-even rate\. The right treatment is the utilization\-based split\. ### 2\. Owner draws Owner compensation tied to billable client hours belongs in direct labor at the utilization\-adjusted share\. Discretionary distributions, phantom equity, and retention bonuses belong in overhead\. The split reflects actual hours, not tax preference\. This is a pricing classification, not a tax classification— and for S\-corp working owners with W\-2 plus distribution splits, talk to your CPA about the tax side\. ### 3\. Marketing salaries For internal pricing, marketing salaries are overhead\. For FAR purposes, general advertising and promotion are unallowable under FAR 31\.205\-1, but direct sales\-type marketing, including bid and proposal costs, are generally allowable under FAR 31\.205\-18 and FAR 31\.205\-38[14](/blog/blog-overhead-architecture#ref-14)\. Many firms reflexively exclude all of it from the calculation and understate overhead\. Take the position that's right for your purpose, and document it\. ### 4\. Payroll burden Indirect expense must include the 15–20% load on total wages[7](/blog/blog-overhead-architecture#ref-7)— employer FICA, unemployment insurance, healthcare contributions, retirement contributions\. Skipping this understates overhead materially\. A firm running $1\.2M in wages and missing the burden line is leaving roughly $180K–$240K out of the indirect column\. ### 5\. Reimbursable expenses Show expenses gross\. Netting reimbursables against the expense line artificially deflates the overhead rate[15](/blog/blog-overhead-architecture#ref-15)\. The General Ledger still has to reconcile, but the rate calculation requires the gross view\. Netting produces a number that can't survive an audit and a billing rate that can't sustain the firm\. Once classifications are clean, the math runs through a small chain— from overhead rate to break\-even to billing rate\. ## From P&L to Billing Rate— A Worked Example Here's the full chain on a real\-shaped firm: $500K direct labor \+ $750K total overhead → 1\.50 overhead rate → 2\.50 break\-even rate → 3\.13 net multiplier \(with 20% target profit\) → a Project Architect earning $57/hour gets billed at $178/hour[19](/blog/blog-overhead-architecture#ref-19)\. Break\-even rate equals overhead rate plus 1\.0[4](/blog/blog-overhead-architecture#ref-4)\. A firm at the industry\-median 1\.62 overhead rate has a 2\.62 break\-even— meaning $2\.62 of billings per $1 of direct labor just to cover costs\. The net multiplier \(net revenue ÷ direct labor\) is the report card\. If it exceeds the break\-even rate, the firm ran profitably\. ```html-table
StepFormulaExample value
1. Direct labor(Salaries × utilization for client work)$500,000
2. Total overhead(Indirect labor + 15–20% payroll burden + non-labor indirect)$750,000
3. Overhead rateOverhead ÷ Direct labor1.50
4. Break-even rateOverhead rate + 1.02.50
5. Net profit multiplier(Break-even × 20% profit target)0.63
6. Net multiplierBreak-even + Net profit multiplier3.13
7. Billing rateHourly salary × Net multiplier$57 × 3.13 = $178/hr
``` The 20% profit lives at the multiplier, not the hourly rate\. Same architect at a 1\.30 overhead rate gets billed around $162/hour\. At 1\.75 overhead, around $194\. Same person\. Different firm structure\. This is why the rate is a pricing tool, not a reporting line item\. With your own number in hand, the next question is what to compare it against\. ## Sanity\-Checking Your Number Against Industry Benchmarks The 2023 Deltek Clarity A&E Industry Study reports a 162% median overhead rate for architecture firms[2](/blog/blog-overhead-architecture#ref-2)\. The industry\-target range is 1\.5–1\.75[3](/blog/blog-overhead-architecture#ref-3)\. The AIA Architect's Handbook of Professional Practice cites a tighter ideal target of 1\.3–1\.5[6](/blog/blog-overhead-architecture#ref-6)\. Where you land in that spread is more diagnostic than absolute\. Per the 2023 Deltek Clarity study— drawn from nearly 700 architecture and engineering firms in the U\.S\. and Canada[23](/blog/blog-overhead-architecture#ref-23)— the median overhead rate is 162%, the median utilization rate is 61%, and net revenue per employee averages $164,935 \(a $5K decline from the prior year\)[11](/blog/blog-overhead-architecture#ref-11)\. ```html-table
BenchmarkSourceValueWhat it means if you're outside the range
Overhead rate (observed)2023 Deltek Clarity2162% medianAbove 175% generally needs corrective action3
Overhead rate (target range)Monograph31.50–1.75Inside the range = healthy; trending up = audit utilization
Overhead rate (ideal)AIA Handbook (via Hyperfine)61.30–1.50Aspirational, not empirical— most firms run higher
Net revenue per employee2023 Deltek Clarity11$164,935Low value with rising overhead = pricing problem
Median utilization2023 Deltek Clarity1061%Below 60% inflates overhead mathematically
``` For [strategic positioning around AI and operational benchmarks](/blog/ai-decision-framework-founders), the trend in your own rate matters more than absolute placement\. Firm size and discipline mix shift expected ranges\. A landscape practice runs different overhead than a hospital specialist\. The AIA Handbook target \(1\.3–1\.5\) is aspirational; the Deltek number reflects what 700 actual firms reported\. Both are honest\. An overhead rate above 175% generally signals corrective action is needed[3](/blog/blog-overhead-architecture#ref-3)— and the fix is usually upstream of cost\. If your rate is climbing year over year, the cause is often hiding in plain sight: utilization\. ## Why Rising Overhead Is Often a Utilization Problem Low utilization mathematically inflates overhead\. When billable hours fall, the same fixed indirect costs spread across fewer direct labor dollars— and the rate climbs\. Many firms diagnose a "cost problem" that's actually a billing problem\. The math is the math: same fixed indirect costs ÷ fewer billable hours = higher overhead rate\. Nothing moved on the expense side\. Architecture firms target 60–65% firm\-wide utilization, with technical staff at 75–85% and principals at 40–50%[9](/blog/blog-overhead-architecture#ref-9)\. The 2023 Deltek Clarity median across firms is 61%[10](/blog/blog-overhead-architecture#ref-10)\. Average annual billable hours per professional employee land between 1,600 and 1,900[21](/blog/blog-overhead-architecture#ref-21)— that's your working range\. A drop of even five percentage points across a 20\-person firm can move the overhead rate by 10–15 percentage points\. Overhead rate is the diagnostic\. Utilization and pricing are the levers\. If your overhead is creeping up, audit utilization before you audit cost structure\. You probably aren't spending more; you're billing less\. All of this becomes practical at the moment you sit down with your accountant or controller\. Here's the diagnostic to bring\. ## Five Diagnostic Questions to Ask Your Accountant Five questions surface whether your overhead rate is defensible\. If your accountant or controller can't answer them in plain language, the rate they hand you isn't ready to price work against\. The questions to ask aren't *what is my overhead rate?*— they're *how did you handle the five classification decisions behind it?* The math is easy\. The thinking is hard\. 1. **How did you split principal salary between direct and indirect labor?** Look for a utilization\-based split, not a default\-all\-to\-direct or default\-all\-to\-indirect\. 2. **Where do owner draws land in the calculation?** Confirm only the share tied to billable client hours is in direct labor; discretionary distributions are in overhead[16](/blog/blog-overhead-architecture#ref-16)\. 3. **What's included in payroll burden, and is it 15–20% of total wages?** Confirm employer FICA, unemployment, healthcare, retirement— not just FICA[7](/blog/blog-overhead-architecture#ref-7)\. 4. **Are reimbursables netted or gross?** Insist on gross presentation in the calculation, even if the P&L shows them netted[15](/blog/blog-overhead-architecture#ref-15)\. 5. **When was this rate last calculated, and how often will it be updated?** Anything older than 6–12 months is stale for pricing\. Outdated rates are one of the most common A&E miscalculations[13](/blog/blog-overhead-architecture#ref-13)\. This [diagnostic framing also applies to measuring AI success](/blog/measuring-ai-success): the right question isn't *what's the number?*— it's *what's behind the number?* Bring this checklist to your next finance review and make whoever produced the rate walk you through each answer\. For firms with public\-sector work, there's one more layer that changes the math\. ## FAR Sidebar— When You Need a Second, Audited Overhead Rate > *Skip this section if you don't do public\-sector work\.* Firms with U\.S\. government contracts above $500,000 generally need an independently audited overhead rate calculated under FAR Part 31[17](/blog/blog-overhead-architecture#ref-17)\. This is a different number than the operator's rate\. Management, not the auditor, owns the responsibility for excluding unallowable costs from all billings to government contracts[18](/blog/blog-overhead-architecture#ref-18)\. The governing rules sit in 48 CFR Part 31\. Common allowables firms miss: bid and proposal costs, certain bonuses, business taxes[14](/blog/blog-overhead-architecture#ref-14)\. Common unallowables: entertainment, alcohol, executive compensation above the AASHTO matrix\. The FAR rate is usually lower than the operator's rate because of the disallowances\. If you do public work, talk to a CPA who specializes in A&E— this is the rare topic where you actively want the accountant in the room\. The AASHTO Uniform Audit and Accounting Guide is the procedure document state DOT auditors work from[18](/blog/blog-overhead-architecture#ref-18)\. Once the number is built and audited \(where required\), the operating question becomes how often to rebuild it\. ## When \(and How Often\) to Recalculate Recalculate annually at minimum\. Recalculate biannually if staffing fluctuates\. Quarterly during periods of growth or contraction\. The rate that priced your January proposals shouldn't still be pricing your November proposals if half your team has changed\. Trigger events worth a fresh calculation: - Hiring or losing 3\+ staff in a quarter - Major lease or software cost change - Principal compensation change - Discipline\-mix shift \(adding interiors, dropping landscape, etc\.\) This is where modern A&E ERPs earn their keep\. Deltek Ajera, Vantagepoint, Monograph, and BQE Core can all produce a real\-time overhead rate view from time tracking and GL data— but only if the underlying classifications \(the five decisions above\) are clean\. The [hidden cost of AI and automation projects](/blog/hidden-costs-ai-projects) often hides exactly here: tools that automate a wrong calculation produce wrong numbers faster\. AI tools and project\-management platforms accelerate the math\. They don't fix the thinking\. That's the firm owner's job\. ## FAQ ### What is a good overhead rate for an architecture firm? The industry\-target range is 1\.5–1\.75 \(150–175%\)[3](/blog/blog-overhead-architecture#ref-3)\. The 2023 Deltek Clarity A&E Industry Study reports a median of 162% across nearly 700 firms[2](/blog/blog-overhead-architecture#ref-2)\. The AIA Architect's Handbook of Professional Practice cites a tighter ideal target of 1\.3–1\.5[6](/blog/blog-overhead-architecture#ref-6)\. Rates above 175% generally call for corrective action\. ### How do you calculate overhead rate for an architecture firm? Total indirect expenses divided by total direct labor[1](/blog/blog-overhead-architecture#ref-1)\. Both values must be in dollars\. The result is a unitless ratio\. A firm with $1\.8M indirect against $1\.2M direct labor has a 1\.5 overhead rate, or 150%\. ### What is the break\-even rate for an architecture firm? Overhead rate plus 1\.0[4](/blog/blog-overhead-architecture#ref-4)\. A firm at a 1\.5 overhead rate must bill $2\.50 for every $1 of direct labor to break even\. At the industry\-median 1\.62, the break\-even climbs to 2\.62\. ### What is the difference between overhead rate and net multiplier? The overhead rate is a cost ratio\. The net multiplier \(net revenue ÷ direct labor\) is a performance ratio[5](/blog/blog-overhead-architecture#ref-5)\. When the net multiplier exceeds the break\-even rate, the firm ran profitably\. The Monograph benchmark net multiplier is approximately 3\.0, with a target range of 2\.75–3\.25\. ### Does owner draw count as direct labor or overhead? Owner compensation tied to actual billable client hours belongs in direct labor at the utilization\-adjusted share\. Non\-billable principal time and discretionary distributions belong in overhead[16](/blog/blog-overhead-architecture#ref-16)\. The split should reflect actual hours, not tax preference\. ### How is FAR overhead rate different from internal overhead rate? The FAR overhead rate excludes "unallowable" costs per FAR Part 31— entertainment, certain marketing under 31\.205\-1, executive compensation above the AASHTO matrix, alcohol[14](/blog/blog-overhead-architecture#ref-14)\. The internal\-pricing rate includes all real operating costs\. Firms with government contracts above $500K typically need both[17](/blog/blog-overhead-architecture#ref-17)[18](/blog/blog-overhead-architecture#ref-18)\. ## From an Opaque Number to an Operating Tool The overhead rate is not a number you receive once a year and accept\. It's the diagnostic you build once, audit yearly, and update whenever the firm changes shape\. Every billing rate, every fee proposal, and every project margin estimate rides on top of it\. The math is easy\. The thinking is what makes the rate defensible\. Principal time, owner draws, marketing salaries, payroll burden, reimbursables— five decisions, taken cleanly, produce a number you can price work against, defend in a meeting, and update when reality changes\. The firm owner owns the rate\. Not the accountant\. Not the software\. If installing the operator's\-rate discipline inside your existing ERP is a heavier lift than your team has bandwidth for, an implementation partner can help map the data flows and classification logic into the systems you already run\. [Dan Cumberland Labs](/services/ai-implementation) works with founder\-led professional services firms on exactly these implementations— pairing domain knowledge with AI and automation tooling so the number you price against is current, defensible, and built from clean inputs\. ## References 1. American Institute of Architects, "Accounting Basics: The Income Statement & KPIs" \(2023\) — [https://www\.aia\.org/resource\-center/accounting\-basics\-income\-statement\-kpis](https://www.aia.org/resource-center/accounting-basics-income-statement-kpis) 2. Deltek, "8 Key Performance Indicators Architecture Firms Can't Ignore" \(2023\) — [https://www\.deltek\.com/en/architecture\-and\-engineering/architecture\-project\-management/kpis\-for\-architects](https://www.deltek.com/en/architecture-and-engineering/architecture-project-management/kpis-for-architects) 3. Monograph, "10 Key Financial Performance Indicators for Architecture Firms to Increase Profitability" \(2024\) — [https://monograph\.com/blog/key\-financial\-performance\-indicators\-architecture](https://monograph.com/blog/key-financial-performance-indicators-architecture) 4. American Institute of Architects, "Accounting Basics: The Income Statement & KPIs" \(2023\) — [https://www\.aia\.org/resource\-center/accounting\-basics\-income\-statement\-kpis](https://www.aia.org/resource-center/accounting-basics-income-statement-kpis) 5. Monograph, "10 Key Financial Performance Indicators for Architecture Firms to Increase Profitability" \(2024\) — [https://monograph\.com/blog/key\-financial\-performance\-indicators\-architecture](https://monograph.com/blog/key-financial-performance-indicators-architecture) 6. Hyperfine Architecture, "ARE 5\.0 — Overhead Rate & Break\-Even Rate" \(2023\) — [https://hyperfinearchitecture\.com/are\-5\-0\-overhead\-rate\-break\-even\-rate/](https://hyperfinearchitecture.com/are-5-0-overhead-rate-break-even-rate/) 7. American Institute of Architects, "Accounting Basics: The Income Statement & KPIs" \(2023\) — [https://www\.aia\.org/resource\-center/accounting\-basics\-income\-statement\-kpis](https://www.aia.org/resource-center/accounting-basics-income-statement-kpis) 8. American Institute of Architects, "Accounting Basics: The Income Statement & KPIs" \(2023\) — [https://www\.aia\.org/resource\-center/accounting\-basics\-income\-statement\-kpis](https://www.aia.org/resource-center/accounting-basics-income-statement-kpis) 9. Monograph, "10 Key Financial Performance Indicators for Architecture Firms to Increase Profitability" \(2024\) — [https://monograph\.com/blog/key\-financial\-performance\-indicators\-architecture](https://monograph.com/blog/key-financial-performance-indicators-architecture) 10. Deltek, "8 Key Performance Indicators Architecture Firms Can't Ignore" \(2023\) — [https://www\.deltek\.com/en/architecture\-and\-engineering/architecture\-project\-management/kpis\-for\-architects](https://www.deltek.com/en/architecture-and-engineering/architecture-project-management/kpis-for-architects) 11. Deltek, "8 Key Performance Indicators Architecture Firms Can't Ignore" \(2023\) — [https://www\.deltek\.com/en/architecture\-and\-engineering/architecture\-project\-management/kpis\-for\-architects](https://www.deltek.com/en/architecture-and-engineering/architecture-project-management/kpis-for-architects) 12. Factor, "How to Calculate Overhead Rate in A&E Firms: A Formula for Profitability" \(2024\) — [https://factorapp\.com/blog/how\-to\-calculate\-overhead\-rate](https://factorapp.com/blog/how-to-calculate-overhead-rate) 13. Dannible & McKee LLP, "Understanding FAR Overhead Calculations and Audits for Architecture and Engineering Firms" \(2024\) — [https://www\.dmcpas\.com/articles/understanding\-far\-overhead\-calculations\-and\-audits\-for\-architecture\-and\-engineering\-firms/](https://www.dmcpas.com/articles/understanding-far-overhead-calculations-and-audits-for-architecture-and-engineering-firms/) 14. Dannible & McKee LLP, "Understanding FAR Overhead Calculations and Audits for Architecture and Engineering Firms" \(2024\) — [https://www\.dmcpas\.com/articles/understanding\-far\-overhead\-calculations\-and\-audits\-for\-architecture\-and\-engineering\-firms/](https://www.dmcpas.com/articles/understanding-far-overhead-calculations-and-audits-for-architecture-and-engineering-firms/) 15. Withum, "Optimizing Your Firm's Overhead Rate" \(2024\) — [https://www\.withum\.com/resources/optimizing\-your\-firms\-overhead\-rate/](https://www.withum.com/resources/optimizing-your-firms-overhead-rate/) 16. Withum, "Optimizing Your Firm's Overhead Rate" \(2024\) — [https://www\.withum\.com/resources/optimizing\-your\-firms\-overhead\-rate/](https://www.withum.com/resources/optimizing-your-firms-overhead-rate/) 17. Dannible & McKee LLP, "Understanding FAR Overhead Calculations and Audits for Architecture and Engineering Firms" \(2024\) — [https://www\.dmcpas\.com/articles/understanding\-far\-overhead\-calculations\-and\-audits\-for\-architecture\-and\-engineering\-firms/](https://www.dmcpas.com/articles/understanding-far-overhead-calculations-and-audits-for-architecture-and-engineering-firms/) 18. Cherry Bekaert, "FAQs: Overhead Rate Audits & FAR Part 31 for A&E Firms" \(2024\) — [https://www\.cbh\.com/insights/articles/faqs\-overhead\-rate\-audits\-far\-part\-31\-for\-ae\-firms/](https://www.cbh.com/insights/articles/faqs-overhead-rate-audits-far-part-31-for-ae-firms/) 19. Monograph, "6 Steps to Calculate Hourly Billing Rate for Architects" \(2024\) — [https://monograph\.com/blog/how\-to\-calculate\-hourly\-billing\-rate\-for\-architects](https://monograph.com/blog/how-to-calculate-hourly-billing-rate-for-architects) 20. OpenAsset, "How to Calculate Cost Rates for Your Architecture Firm" \(2023\) — [https://openasset\.com/resources/how\-to\-calculate\-cost\-rates\-for\-your\-architecture\-practice\-to\-increase\-profit/](https://openasset.com/resources/how-to-calculate-cost-rates-for-your-architecture-practice-to-increase-profit/) 21. Hyperfine Architecture, "ARE 5\.0 — Overhead Rate & Break\-Even Rate" \(2023\) — [https://hyperfinearchitecture\.com/are\-5\-0\-overhead\-rate\-break\-even\-rate/](https://hyperfinearchitecture.com/are-5-0-overhead-rate-break-even-rate/) 22. Deltek, "Deltek Releases the 45th Annual Deltek Clarity Architecture & Engineering Industry Study" \(2024\) — [https://www\.deltek\.com/en/about/media\-center/press\-releases/2024/deltek\-releases\-the\-45th\-annual\-deltek\-clarity\-ae\-industry\-study](https://www.deltek.com/en/about/media-center/press-releases/2024/deltek-releases-the-45th-annual-deltek-clarity-ae-industry-study) --- Source: https://dancumberlandlabs.com/blog/overhead-architecture/