What Overhead Costs Are
Everything that is incurred without being directly attributable to an individual project or cost unit: rent and business rates, IT infrastructure and software licences, accountancy fees, executive management, sales, marketing, staff training, employer liabilities, and professional indemnity insurance.
Calculation
Overhead Absorption Rate = (Overhead Costs ÷ Allocation Base) × 100
Direct labour costs of billable or productive units typically serve as the allocation base (under traditional absorption costing). In labour-intensive professional and service businesses, rates often range between 60% and 120% — a financial metric that is meaningful primarily when analysed against your own business history and historical trends rather than broad industry benchmarks.
Choosing the Allocation Base
The allocation base should reflect a realistic cause-and-effect relationship with the indirect overheads incurred. Where this is not the case — for instance, where different teams, workstations, or departments require vastly different equipment, software, or premises footprints — dividing overheads into multiple cost centres with distinct absorption rates is far more accurate than applying a single organisation-wide blanket rate.
Cost Remanence (Cost Stickiness)
Overhead expenditure rarely drops in direct proportion when client demand or billable hours fall. Calculating your overhead absorption rate based solely on a high-performing financial year will result in systematic under-recovery during a business downturn. Factoring conservative capacity utilisation and realistic billable targets into your cost calculation mitigates this operational risk.
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