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Calculating your Indirect Cost Rate and Its Importance

Identifying, calculating, and managing the numerous costs incurred by a company is a tough task. Most of the attention is put on direct costs. But, it is the indirect cost that can improve management, data tracking, and analysis. Using the right tools and methods, businesses can take control and allocate direct costs the right way for more savings.


The Indirect Cost Rate Formula


Knowing the indirect costs matters. And while many finance teams can easily identify direct costs, identifying the indirect cost is a bit more complex. Direct costs are pretty straightforward. It entails identifying direct labor costs, professional costs, and raw materials. Unfortunately, many finance teams confused indirect costs with terms like overhead costs, administrative costs, etc. It's important to understand the true meaning of the term indirect costs.


Indirect costs have no direct connection to a particular project, program, or product. Indirect costs are spread across the business because they are necessary to finish daily operations. Things like IT services, insurance, capital expenditures, office supplies, and salaries are all good examples of indirect costs. Each one can be allocated or calculated using an indirect cost rate formula or method.


One basic method is fixed cost classification. Identifying fixed costs, such as rent and labor costs is entailed in this method. For example, knowing which department ordered supplies and knowing what department of supplies was shared with is a part of it. And the depreciation of office supplies ordered is also included.


The proportionate allocation method is another method used. With this method, indirect costs are spread out among business units and different company departments. The cost of services and goods are used. Then, a percentage is assigned. This includes things like IT services and cleaning services.


There is also the activity-based cost allocation approach. This message takes a lot more time. However, it is the most accurate method. Collecting the data needed to implement this method includes identifying all business activities, separating those activities into direct or indirect costs, and then analyzing those costs.


There is also software available for finance teams to use when calculating indirect costs. Different types of software can calculate, streamline tracking, allocate indirect costs and identify indirect costs. It's an automated process that helps categorize and capture all spending of a company. All of the data can then be analyzed by the finance team. Also, the programs can be set up to generate budgets, reports, and future forecasts of the business. There are different categories in this type of software. You can choose the categories that you won't use, such as management or contracts. This type of tool is handy for financing teams. Also, invoice fraud can be eliminated with this type of software. Keep in mind that invoice fraud can wreak havoc when trying to calculate indirect costs.


There are many advantages to identifying indirect costs. It makes it easier for companies to plan and make strategic, developmental, and spending decisions. It also helps reduce waste and needless spending. It ensures that each department of your company is operating efficiently and supports company goals to ramp up revenue. Overall, profitability and productivity are enhanced.


Whether you choose to used traditional methods or software to identify indirect costs, it's an important task to do for a business. It is definitely not a task that should be overlooked by any company. Request a demo below to see how AccountingDepartment.com can help!

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