Developing Rates for Government Contracts, Part 2

Welcome back for Part II!

Last post we discussed the various type of contracts (Firm Fixed Price, Time & Materials, and Cost Plus Fixed Fee) and started to get into what we call indirect cost “pools” – Fringe, Overhead and General & Administrative. For this post, we will delve a bit further into what makes up the “pools”, how they are approved by the government and how you use the pools to develop the price per hour you can charge to the government.

So what make up these so called “pools”? On this hot summer day as I write this I wish they were cool places to dip your toe. Alas, they are simply categories of expenses….

Imagine that you have three boxes and a huge pile of receipts. Your accountant would prefer you file the expenses into various “types” of expenses or the three boxes rather than the big pile and the government is no different. Each company can decide exactly how to divide their expenses but this is the most common approach:

What Accounting
System Can I use?

This topic could be a book in itself but suffice it to say that you can use whatever accounting system you would like as long as you 1) set up your pools correctly and 2) have set procedures in place that you follow.

When I started my company I began by using Quickbooks which is cheap and easy to use. However, it is NOT set up to do government cost accounting so creating the pool system can be a bit more complicated. As Zekiah grew, we migrated to Deltek, which is preferred by the government as it tracks your pools effectively and has a rigid audit trail.

Direct Labor Rate. This is easy. You take the salary of the person you are proposing and divide by 2,080 (the number of hours in a year). For example, if you pay someone $50,000 per year, their Direct Labor Rate is $24.04.

Indirect Costs. Indirect Costs are anything that you cannot directly charge to the government such as paying for the employee’s health care premiums or items like rent, accountants or paper for the copier. This is the complicated part and I’ll explain a bit more in depth below.

Fee which is your Profit on the task. This is negotiated within your proposal and can be either a fixed number ($1,000) or a percentage of the billed amount (5%).

So… back to the Indirect Costs. Indirect Costs are further broken into sub pools (or categories). The most common approach to this division is:

Fringe Pool – items such as health care, retirement contributions, vacation, sick, and workman’s compensation.

Overhead Pool – items that cannot be billed directly to a contract but can be attributed to the cost of doing business with one or more customers. For example, computers, rent for billable employees, salary paid to an employee between two projects or utility costs for space allocated to billable employees.

Some companies divide their Overhead Pool into two distinct pools: one for Company Site Employees and one Government Site Employees. This is because it obviously costs us more in overhead costs to employee someone who works on our site than on a government site. It doesn’t seem fair to allocate (and thus charge) costs for Company Site employees to clients who are providing those materials such as desks, space to work and computers for us.

General & Administrative — items that attributable to running your business in general. Examples include the salary of the President of your company (unless the President is a billable employee and then you should divide the salary proportionately into the correct pools), rent for the area where administrative personnel work, accountant and lawyer fees.

Once you have divided your costs into their various pools, you can calculate percentage costs for each pool based on the total Direct Labor costs. See the charts below for a very simplified sample budget and the corresponding “Indirect Rates” that were derived.

Fringe Pool
Description

Cost

Holiday Pay 10,000
Annual Leave 12,000
Sick Pay 6,000
Health Insurance 18,000
FICA 20,000
Federal Unemployment 500
State Unemployment 1,000
Profit Sharing 20,000
Workman’s Compensation 500
Training & Education 4,000
Retirement 5,000
TOTAL $97,000
Overhead Pool
Description

Cost

Overhead Labor 10,000
Bonuses 5,000
Allocated Fringe 3,100
Meetings & Conferences 5,000
Satellite Office 20,000
Recruitment 1,500
Travel & Auto 1,000
Hardware 6,000
Software 1,500
Printing 1,400
Telephone 1,800
TOTAL $56,300
General & Administrative (G&A) Pool
Description

Cost

G&A Labor 50,000
Bonuses 1,000
Allocated Fringe 15,100
General Insurance 4,000
Attorney 2,300
Accountant 4,000
Internet 1,000
Postage 200
TOTAL $77,600
Labor Base
Description

Cost

Direct Labor 280,000
Overhead Labor 10,000
G&A Labor 50,000
TOTAL $340,000

Now, once you have your budget for the year you can start to calculate what your indirect rates are…

Let’s start with Fringe. Your total cost for Fringe is $97,000 and your total Labor Base is $340,000. To compute your Fringe Rate you divide Fringe by the Labor Base total for a percentage of 28.5%.

The other indirect rates are calculated using the same methodology as you can see below.

Indirect Rate Calculation
Pool Pool Costs Labor Base Cost

Derived Rate

Fringe $97,000 $340,000 28.5%
Overhead $56,300 $340,000 16.6%
G&A $77,600 $340,000 22.8%

Once you have the indirect rates, you can use them to create your Cost Plus Fixed Fee rates that you bill to the government.

Salary Direct Labor Rate Fringe@ 28.5% Subtotal Ovrhd@ 16.6% Subtotal G&A@ 22.8% Subtotal Fee@ 5% Total Hourly Rate
$50,0000 24.04 6.85 30.89 5.13 36.02 8.21 44.23 2.21 $46.44
$100,000 48.08 13.70 61.78 10.26 72.04 16.43 88.47 4.42 $92.89

Your proposed budget and indirect rates are submitted to the Defense Contracting Auditing Agency (DCAA) at the beginning of the year and are called Provisional Rates. DCAA will either approve or request a change to what you proposed. Once they are approved you can use those indirect rates to bill the government on your CPFF contracts.

Provisional Rate are just that … provisional. They are based off what you propose in your budget. You do your best to stay within the budget but things happen and your actual numbers are sure to not exactly match the budget. At the close out of the contract you will apply your actual indirect rates (based on your actual expenditures) to the direct labor expended and do a reconciliation between what was billed and the actual costs incurred on the contract. At that point, you will either owe the government back some money (if they were lower than budgeted) or you can attempt to collect additional fees from the government (if they were higher than budgeted).

So… that is your quick overview of how to create a government contracting budget and how it is used to create Cost Plus Fixed Fee rates. This is an immensely simplified view to give you a basic understanding. If you have questions or need further explanation please contact us for our business consulting services.

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