Why Indirect Rates Matter

Why Indirect Rates Matter 

Indirect rates are not just accounting abstractions; they are the financial backbone of every government contractor’s business model. In the GovCon ecosystem, few firms survive long-term without a robust understanding of how these rates work and why they matter.

At their core, indirect rates determine how a contractor recovers the true cost of doing business. Direct costs—such as labor hours charged to a contract or raw materials purchased for a deliverable—are only part of the picture. Every contractor also carries substantial indirect costs: employee benefits, paid leave, recruiting, IT systems, accounting and HR staff, corporate insurance, rent, utilities, training, and business development. If a contractor fails to allocate these indirect costs correctly across contracts, they either under-recover (losing money) or over-recover (which can lead to disallowed costs, refunds, and reputational damage with auditors and contracting officers).

Under FAR Part 31 – Contract Cost Principles and Procedures, indirect rates play a compliance role as well. The FAR establishes that all costs claimed under government contracts must meet three tests: they must be allowable (permitted under the regulations), reasonable (prudent for the circumstances), and allocable (fairly assigned to the benefiting contracts). Indirect rates are the mechanism by which contractors recover their costs. They ensure that when a contractor bills an hour of labor or a unit of material, the government also pays its fair share of the indirect structure needed to support that work—but not more.

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