Overhead allocation strategies for accurate job costing
Master overhead allocation methods to ensure every quote captures your true costs including rent, utilities, insurance, and indirect labor.
1) Calculate total overhead burden
Identify and quantify all indirect costs that must be recovered through pricing.
| Overhead Category | Examples | Typical % of Revenue |
|---|---|---|
| Facilities | Rent, utilities, property tax, insurance, maintenance | 8-15% |
| Equipment | Depreciation, lease payments, repairs, calibration | 10-20% |
| Indirect labor | Supervision, QC, scheduling, shipping, admin | 12-25% |
| Support functions | IT, HR, accounting, sales, engineering | 5-12% |
- Annual calculation: Sum all overhead expenses from P&L; exclude direct material and direct labor.
- Fixed vs variable: Separate fixed (rent, salaries) from variable (utilities, consumables) for better utilization modeling.
- Benchmark: Total overhead typically 35-60% of revenue for job shops; higher for capital-intensive operations.
2) Choose allocation method by shop type
Machine Hour Rate (capital-intensive)
Formula: Overhead ÷ Total machine hours available
Best for: Laser cutting, CNC machining, high equipment depreciation
Example: $500K overhead ÷ 4,000 hrs = $125/machine-hr
Direct Labor % (traditional job shops)
Formula: Overhead ÷ Direct labor cost × 100%
Best for: Labor-intensive operations, manual assembly
Example: $400K overhead ÷ $600K labor = 67% markup
Activity-Based Costing (complex multi-process)
Formula: Assign costs to activities, then allocate based on activity drivers
Best for: Mixed operations with multiple cost pools
Example: Setup cost pool allocated by # setups; QC pool by inspection time
3) Adjust for utilization and capacity
Utilization Impact on Rates
| Utilization | Available Hours | Billable Hours | Overhead/Hr |
|---|---|---|---|
| 50% (low) | 4,000 | 2,000 | $250/hr |
| 75% (target) | 4,000 | 3,000 | $167/hr |
| 90% (high) | 4,000 | 3,600 | $139/hr |
4) Department-specific overhead pools
Different departments have different cost structures; separate pools improve accuracy.
| Department | Primary Driver | Cost Profile | Typical OH Rate |
|---|---|---|---|
| Laser cutting | Machine hours | High equipment depreciation, low labor | $120-180/hr |
| Bending/forming | Machine hours | Medium equipment, medium labor | $80-120/hr |
| Welding/assembly | Labor hours | Low equipment, high skilled labor | 50-80% of DL |
| Finishing/coating | Square footage | High facility cost, environmental compliance | $60-100/hr |
5) Quarterly review and rate reconciliation
Prevent over/under-absorption by reviewing actual vs budgeted overhead quarterly.
- Compare actual overhead: Review P&L; identify variances (utilities spike, unplanned repairs, etc.).
- Compare actual hours: Did utilization match plan? If lower, rates need adjustment for Q next.
- True-up mechanism: If overhead under-absorbed (rates too low), adjust next quarter rates +10-15% to recover.
- Document assumptions: Record utilization target, major cost changes, and rate effective dates.
- Communicate to sales: Share rate changes with lead time; avoid mid-quote surprises.