For organizations pursuing Small Business Innovation Research (SBIR) contract or grant funding, indirect cost rates play a critical role in both compliance and financial performance. These rates determine both your profitability and (to a lesser extent) competitiveness in government-funded work as they are used by federal agencies to evaluate your organization.
Understanding how to project and evaluate an indirect cost rate — often expressed through a “multiplier” that captures the relationship between direct labor and total project cost — can help your business avoid cash flow challenges and better align pricing with government expectations.
Additional key benefits of understanding and projecting an indirect cost rate include:
- Protecting profitability and cash flow by ensuring indirect costs are appropriately accounted for in pricing.
- Improving pricing alignment with government expectations, reducing the risk of price push-back.
- Enhancing competitiveness for funding by positioning your multiplier within ranges the government considers reasonable.
- Driving operational efficiency over time, as growth typically brings expectations for lower indirect rates and better cost management.
What Is a Multiplier and How Does Your Indirect Cost Rate Compare to Others?
Every business needs to make a profit to stay healthy and thrive. As a government contractor or grantee, you need to understand how the government views your “multiplier” to avoid losing money. Your indirect cost rate may hurt your cash flow and profitability. We’ve put this practice into simple terms below.
Understanding Your Multiplier: An Example
If you take $1 in labor and add all your overhead rates and fees to it, how much do you charge the government?
Let’s say you make $80,000 a year for 2,000 hours of work, so you’re paying yourself $40 an hour. If you charge a project $40 for labor, how much do you add to burden that $40 for indirect costs? $80 would be a multiplier of 2.0 ($80/$40); $120 would be a multiplier of 3.0 ($120/$40). That is how the government views your multiplier.
The “Right” Multiplier for Phase II SBIR Funding
The multiplier is different for each company and each situation, though, based on industry experience supporting SBIR awardees and government contractors, there are some common truths.
When we ask our Department of Defense (DoD)-funded SBIR clients — who have evolved from a project into a business, and have moved out of the garage into a facility and have employees — what kind of feedback they received on their multiplier (pricing), organizations often receive consistent feedback from agencies regarding how their pricing compares to market expectations.
<2.4 Multiplier
When our clients’ multiplier is less than 2.4, there’s typically no pushback or surprise from their government customer about price. We conclude that the government sees them as inexpensive.
2.4 to 2.7 Multiplier
At a multiplier of 2.4 to 2.7, there’s usually a normal business conversation about cost and pricing, expectation for performance and so on. The government may have some questions about specific costs, but ultimately, the multiplier is within the normal range.
2.7 to 3.0 Multiplier
At a multiplier of 2.7 to 3.0, our clients begin to experience increased scrutiny and justification tied to performance. This response suggests that pricing may be expensive.
>3.0 Multiplier
Generally, at a multiplier of greater than 3.0, the government will question doing business with the organization.
However, when it comes to multipliers for SBIR Phase II funding, there are outliers. Organizations delivering highly specialized or innovative capabilities may justify higher multiples when supported by strong technical value and limited competition.
For instance, we have a client whose multiplier is 3.4, but the federal government has justified it because what they do is so leading-edge. Their intellectual property and distinctive capabilities are difficult to find elsewhere, so the government pays 3.4 times their labor costs for it.
They’re an outlier, but they’re competing against you for SBIR Phase II funding. These ranges provide general context, so acceptable multipliers ultimately depend on several factors, including technical complexity, availability of substitutes, geographic labor markets and agency expectations.
Common Indirect Cost Rates Methodologies
Organizations may use different methodologies to structure indirect cost rates, depending on their operations and cost drivers. There is a myriad of methodologies for calculating indirect cost rates. Here are some common ways:
Single-tiered Indirect Rate
Indirect Expense ÷ Direct Labor
When you fill out a proposal, the single-tiered method is the simplest way to calculate the indirect rate. A single-tier indirect rate applies all indirect expenses into one cost pool, which is typically allocated over direct labor. This structure works well for software companies and companies that have no direct costs other than labor to burden.
Two-tiered Indirect Rate: An Overhead and a G&A Rate
Overhead (Labor)
G&A (Management Functions)
A two-tier structure separates indirect costs into distinct pools, typically overhead (e.g., expensive engineers) and general and administrative (G&A), which are less expensive. The denominator for engineering overhead is direct labor, so when you have expensive engineers work on your innovation, their labor is burdened with engineering overhead for a rate of x. But you may also have a separate G&A rate for your administrative people who handle subcontractors, materials, travel and the like.
How you pool your expenses can change the appearance of your indirect rate — and your ability to better compete for SBIR Phase II funding, because you want to distribute your indirect expenses towards the direct costs that your customer sees as valuable.
The goal is to set up indirect cost pools that most appropriately benefit your business. Again, nothing is set in stone; the appropriate structure will vary based on the organization’s cost drivers, whether labor-driven (e.g., engineering firms) or facility-driven (e.g., manufacturing environments).
National Institutes of Health (NIH) Grants: Fringe and F&A Rates
For organizations receiving NIH funding, costs are pooled differently. Cost structures often include fringe, and facilities & administrative (F&A) rates.
Fringe Benefit Rates
We see fringe benefits rates for our grantees’ trend between 25% and 40% - largely driven by the competition for labor in their geography. For example, our San Francisco clients are competing against companies like Google for labor, which picks them up by bus, takes care of their dry cleaning and feeds them. So, organizations in high-cost regions may experience elevated fringe and F&A rates due to competitive compensation and benefits expectations.
Growth Should Drive Efficiencies
As your organization grows, the government generally expects your indirect rates to decrease due to natural increased operational efficiency, with the rare exception of an organization that’s doing something incredibly cutting-edge. Growth can introduce economies of scale, particularly in administrative functions, reducing the relative burden of indirect costs over time and economies of scale. For instance, you don’t need 12 more accountants because you’re doing $20 million in revenue.
Get the Help You Need With Your F&A Rate or Indirect Cost Rate
At Cherry Bekaert, our government contracting advisors are well-versed in indirect cost rates and help our clients propose and negotiate them.
Ready to get started? Speak with a government funding award advisor and ask about our free indirect cost rate projection template and free cost proposal service.
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