• # MIE Solutions Blog

Welcome to the MIE Solutions Job Shop Estimating  blog.   Fabrication software as in sheet metal software and manufacturing software deals with shop rates extensively for costing.

There are basically 3 ways to calculate overhead absorption rates which is used to provide your shop sell rate during quoting and estimating.

1. Company Overhead Absorption Rate
2. Percentage Overhead Absorption Rate
3. Work Center Overhead Absorption Rate

Each of these three ways of calculating your overhead absorption has both positive’s and negatives.

# Percentage Overhead Absorption Rate

What does an overhead percentage mean?   An example would be a 150% overhead percentage which  means that for every \$1.00 of direct labor billed to the customer, the business must collect an additional \$1.50 (\$1.00 x 150%) for that custom just to cover costs.   There are potentially large variations between total direct labor wage and direct labor cost.    The question is how do we figure the overhead absorption rate.

## Definitions

All expenses found on the company’s income statement (also known as the
profit and loss statement).

All expenses found on the company’s income statement (also known as the profit and loss statement).

All costs found on the income statement except for direct labor, direct materials, and costs attributable to outside subcontractors that can be billed directly to a customer’s account. Overhead expenses are absorbed by the business and factored into the selling price as a percentage of the direct labor cost. They include indirect costs such as accounting, advertising, depreciation, indirect labor, insurance, interest, legal fees, rent, repairs, supplies, taxes, telephone, travel, and utilities.

Direct Labor

Labor used to produce products and services purchased by customers. These man-hours are directly attributable to customer activity.

Indirect Labor

Labor used to provide supporting services to the business such as accounting, clerical, custodial, customer services, management, purchasing, sales, and warehousing. These man-hours support business functions that are not directly chargeable to the customer.

Direct Materials

Materials used in the final product or service purchased by customers. These materials are charged directly to the customer’s account.

Ratio between direct labor and overhead expenses. This percentage is used to allocate overhead expenses proportionately to direct labor dollars billed to customers.

## How To Calculate Overhead Percentage

Step 1 Determine the "average" hourly wage paid to direct labor employees.

Step 2 Estimate direct labor workdays available in the calendar year.

Step 3 Estimate billable direct labor hours for work year.

Step 4 Estimate billable direct labor dollars for work year.

Step 5 Estimate non-billable direct labor dollars for work year.

Step 6 Estimate all overhead expenses for work year to include non-billable direct labor.

Step 7 Calculate the annual overhead percentage.

## Example

Would your shop rate be Avg Direct Labor Rate +Overhead Rate (Average Direct Labor Rate x Overhead %)

is  Direct Labor Costs

Is this your sell rate?   No

A machine shop rate for a job shop manufacturer is not that difficult to compute once you have your income sheet calculations available.   Its important to calculate your shop rate for estimating accurately because if you are off by much you will be losing money continuously.   A sheet metal software package needs to be able to handle calculating overhead rates based on percentage if its applicable to the specific industry.

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