Being a government contractor, whether you’re a novice or a veteran, comes with its own unique set of challenges. One of the most significant is the constant need to optimize indirect rates. These rates can be the deciding factor between securing new contracts and expanding your business or remaining static and missing out on opportunities. As your business grows and evolves, your indirect rates should follow suit. Regularly evaluating your rates to ensure they align with your company’s strategic plan and maximize the recovery of your allowable costs is crucial to building a thriving company.
Understanding Indirect Rates
Indirect rates represent the costs incurred by a government contractor that cannot be directly attributed to a specific contract. These costs include overhead expenses, fringe benefits, facilities, and other indirect costs. Understanding your indirect rates is essential as they directly impact your pricing and competitiveness in the government contracting arena.
Navigating the Market and Aligning with Your Strategic Goals
The stability of the government contracting market makes it an attractive business environment. The U.S. government consistently has funds available. Despite political events that might affect the market, such as government shutdowns or sequestration, annual funding levels remain relatively consistent. The federal government’s funding for innovative research also opens up exciting opportunities for new and emerging businesses.
Compliance with Government Regulations
Government contracting is highly regulated, and compliance with applicable rules and regulations is crucial. A sound indirect rate strategy should take into account the government’s cost accounting standards (CAS) and the Federal Acquisition Regulation (FAR). Adhering to these regulations demonstrates your commitment to transparency and accountability, which can give you a competitive edge.
Understanding Wrap Rates
Wrap rates provide a summary of your business’s anticipated budgeted costs. Knowing how to structure and calculate your costs can result in a different wrap rate. This can be beneficial when your company diversifies into new business lines that require a different wrap rate. A company’s wrap rate is typically derived from the final stated indirect rates burdened on direct labor dollars. For companies with a typical fringe, overhead, and G&A rate structure, the wrap rate formula is ($1*($1+fringe rate)($1+overhead rate)($1+G&A rate) = the break-even wrap rate. This is the point from which you can begin to make business decisions based on the fee percentage added for each bid.
Understanding Common Indirect Cost Pools
Indirect cost pools are a critical component of the indirect rate strategy. They include:
- Fringe: These are statutory and discretionary costs for employees. Examples include PTO and health insurance premiums. These expenses help companies retain the talent they hire.
- Overhead: These are costs required to support existing contracts but cannot be directly attributed to any specific business activity, product, or service. Examples include labor that manages all the direct personnel but does not work directly on contracts, training and conferences costs, equipment used for multiple contracts, and IT costs.
- General and Administrative (G&A): These are expenditures related to a business’s daily operations and back-office operations that are not directly associated with producing goods or services. Examples include executive management costs, accounting fees, legal, business development, and service center costs.
Choosing the Right Rate Structure
The burden component is the wild card in the wrap rate, making it crucial to strategize the best rate structures for your business. There are three common rate structures considered the “standard.”
- Three-Tier Structure: This is the most common for professional services and is popular with auditors and contracting officers. It includes a fringe rate, one or multiple overhead rates, and a G&A rate with a base of either total cost input (TCI) or value-added. This structure is preferred by most professional services government contractors.
- Two-Tier Structure: This structure is not as popular with auditors, and only limited contractors use this model. It often yields a higher WRAP rate. It includes one or multiple overhead rates and a G&A rate with a base of either total cost input (TCI) or value-added. The fringe is an intermediate pool allocated to both overhead and G&A, pushing more costs to the pool and removing costs from the base, thus yielding a higher WRAP rate.
- Single Pool/Single Element Structure: This structure is used by about 1% of businesses, including joint ventures, startup companies, construction, and manufacturing companies. It includes one pool for all the indirect costs, as most of the costs incurred by the business are charged directly.
The Role of G&A in Winning or Losing
Staying competitive sometimes requires using additional methods to lower the G&A rate. It’s a classic conundrum: which comes first, the chicken or the egg? The same dilemma applies to achieving a low G&A rate. To achieve a low rate, you need to secure more work to expand the base. But how can you secure more work if your G&A rate isn’t attractive? Businesses with a slightly higher G&A rate can utilize discounted or impacted rates. When your actual G&A rate is high compared to competitors, offering to apply a discounted G&A rate to the subcontractor and consultant costs can be a wise move. For bidding and pricing strategy, you can discount the G&A on the subs when using a total cost input (TCI) G&A base.
What is the Best Indirect Rate Structure?
The best structure for your business is one that your customers are familiar with, allows you to maximize the recovery of your costs, and helps you secure new business opportunities. Keeping up-to-date with your indirect rates can give your business an edge and make the jobs of your auditors and customers easier. If your primary agency (or prime) customer has a preferred calculation model for rates, it’s beneficial to use it, as it could provide a competitive edge in the bidding process. Structures and pools don’t need to be complicated, so keep them simple and keep your bases large. Choose a structure with enough flexibility to support your growth and ability to secure new contracts for your government contracting business. RGCI has extensive experience in assisting contractors through this process.
Redstone GCI assists contractors throughout the U.S. and internationally with understanding the government’s expectations and requirements for developing an indirect rate structure that complies with FAR and CAS, if applicable. Our team of experts not only advises contractors on compliance issues associated with indirect rate structures, but we also assist with strategies and approaches for enhancing and restructuring contractor’s indirect rate structures to become more competitive and attain a more significant recovery of indirect cost.