What is the overhead costs formula?
The overhead costs formula is one line of arithmetic: overhead rate equals total overhead costs divided by total billable hours, for the same period. Total overhead is every indirect cost, from rent and software to the salaries of people and the hours of time not charged to clients. Total billable hours are the hours actually sold to clients in that period. The result is a dollar figure per billable hour: the amount each sold hour has to earn, on top of the cost of the person working it, before the agency makes any profit at all.
A second form of the formula divides overhead by direct labor cost instead of by hours and gives a percentage, which some agencies prefer because it scales with seniority. Both describe the same thing: how much of the business each unit of work is carrying.
Why it matters
Why the overhead costs formula matters
Without it, pricing is guesswork. An agency that knows its people cost sixty dollars an hour and charges a hundred and fifty believes it is making a healthy margin, until the formula shows that overhead adds another seventy per billable hour and the real margin is twenty. The formula turns the overhead from an abstract total into a number that sits inside every estimate, which is the only place it can be recovered. It also tells the agency what a change does: hire a non-billable role and the numerator rises; win a retainer that fills the team and the denominator rises; the rate moves accordingly, and so should the prices.
It is also a useful honesty test. The denominator comes from timesheets, and the first time an agency runs the formula is often the first time it discovers how incomplete its time tracking is.
In practice
How the overhead costs formula works in practice
- 01
Take a full year of real numbers. Pull every expense not coded to a client job and total it: that is the overhead, and it should include non-billable salary time, not only rent and tools. Pull the billable hours for the same year from the time-tracking system. Divide. Say the overhead was six hundred thousand and the billable hours were twelve thousand; the overhead rate is fifty dollars for every billable hour.
- 02
Then use it. Add the rate to the loaded hourly cost of each role, add the target margin, and the result is the internal rate used to estimate every job. Rerun the formula at least once a year, and again when headcount or fixed costs move, because the rate is only true for the period it was calculated from.
Watch out
What people get wrong about the overhead costs formula
Dividing by total hours worked instead of billable hours. That spreads the overhead across time nobody pays for, makes the rate look smaller than it is and underprices every job. The second mistake is leaving the owner's own time out of the overhead. The third is running the formula on a budget rather than on actuals: a planned overhead and a hoped-for utilization produce a rate that describes an agency that does not exist.
And the one that catches growing agencies: calculating it once. The rate from the year the agency had eight people is wrong for the year it has fourteen.
