How to Build the Indirect Rate in Your SBIR Phase II Cost Proposal

The technical volume of a Phase II proposal gets most of a founder's attention. The cost volume is where a company can quietly lose money, or lose credibility, over a single number: the indirect rate. This guide covers how to build one, and how to document it so it holds up under review.

The short answer

An indirect rate is a pool of shared costs divided by a base, usually direct labor. Build it from your actual accounting records, keep the calculation and the transactions behind it, and use the same cost structure in your proposal that you use in your books. Add the fee, where your agency allows one, on top. For the underlying mechanics, see How to Calculate Indirect Rates in QuickBooks Online.

What an indirect rate is, and why Phase II cares

An indirect rate covers a company's general cost of being in business: benefits, rent, accounting, insurance, and the time leadership spends managing the company rather than billing a specific project. A customer, including an SBIR agency, should pay for the actual cost of the work plus a fair share of what it costs to keep the business running.

The U.S. Small Business Administration's own guidance for SBIR applicants is direct about where that number has to come from: never another company's indirect rate, and never a nearby university's rate, because neither reflects your actual costs. A defensible rate is always your own, derived from your own books.

In Phase I, a small award and a fixed price can hide a rough estimate. In Phase II, a contracting officer needs confidence that the rate was estimated accurately, and a pre-award survey can include a review of the proposed rates. If the Phase II is cost-reimbursable, that same rate becomes the basis for billing. The full pre-award picture is covered in SBIR Phase I to Phase II: How to Get Your Accounting Ready Before the Award.

The common pools

Most small companies group indirect costs into fringe, overhead, and G&A, each with its own allocation base: fringe usually sits on direct labor, overhead on direct labor (often labor plus fringe, as in the example below), and G&A on total cost input. We cover how to sort any expense into the right pool in How to Classify Indirect Costs (Fringe, Overhead, and G&A), and the pool-over-base mechanics in Cost Pools Explained.

Your structure does not need to match this exactly. A single-rate structure is common for very small companies; what matters is choosing one, documenting it, applying it consistently, and keeping unallowable costs out of every pool before any rate is calculated.

A worked example: from $50 an hour to a bid rate

In the short demo below, Brian Wendroff, CPA, Co-founder of WiseCost and Managing Partner at Wendroff & Associates, CPA, builds a wrap rate from QuickBooks Online data, one layer at a time.

Here are the same layers stacked on one hour of an engineer who costs $50:

Layer	Rate	Added	Running total per hour
Direct labor			$50.00
Fringe	30% of direct labor	$15.00	$65.00
Overhead	40% of labor plus fringe	$26.00	$91.00
G&A	18% of the total so far	$16.38	$107.38
Fee	8% of total cost	$8.59	$115.97

Step through the same build-up one layer at a time. Each click adds the next layer on top of the running total, which is why overhead and G&A add more dollars than their percentages suggest:

Two things stand out. First, $107.38 is the break-even cost of that hour: anything billed below it loses money. Second, the indirect layers ($57.38) add up to more than the direct labor itself ($50.00), which is common, and exactly why a proposal priced only on salaries tends to badly undercharge.

The fee line is for illustration. On an SBIR, the fee follows the agency's own rules: NIH and DOE, for example, allow up to 7% of total costs (direct plus indirect). Use the figure in your solicitation, not the 8% shown here.

The wrap rate

Multiplying the three indirect layers together gives a single multiplier, often called a wrap rate: 1.30 × 1.40 × 1.18, about 2.15 in this example. Any direct labor rate times 2.15 gives its fully burdened cost before fee, which makes it straightforward to price other roles on the team. As a rough benchmark, a multiplier around 1.5 is bare-bones, around 2.0 is average, and well above 2.0 starts to look less competitive, though a company with lab space and specialized benefits may sit higher for good reasons. The goal is not to force the number under a threshold. It is to know the number and be able to explain what is in it.

Do not lowball the rate

Shaving an indirect rate to make a proposal look more attractive is a pattern auditors are specifically trained to catch. Government reviewers call it "buying in," and when they see it on cost-reimbursable work they can respond by capping the indirect rates for the life of the award, leaving the company unable to recover real costs afterward. We cover this pattern, and why it backfires, in What Is "Buying In" in Government Contracting?

Price and cost analysts on the government side also evaluate whether a proposed rate is realistic enough for the company to survive the contract. A rate that is too low can be rejected outright as unsustainable, or accepted and capped, which is the more expensive outcome of the two.

What backup documentation looks like

A defensible rate comes with its receipts. Before submitting a Phase II cost proposal, a company should have:

The rate calculation by account, showing which general ledger accounts make up each pool and each base.
The transactions behind each account, so any rate can be traced back to source entries.
Labor distribution records showing how approved hours became labor dollars across projects and indirect accounts, reconciled to payroll.
A chart of accounts mapping, showing which accounts are direct, which belong to each pool, and which are unallowable.
Written assumptions for any projected period, such as planned hires or a new lease, kept separate from actuals.

A missing step here is one of the most common review findings: rates developed without the backup to support them. For a young company with only a Phase I behind it, that history may be short. Start with what the books actually show, and treat every projection as an explicit, documented assumption rather than a number folded quietly into the rate.

After the award: provisional and final rates

If the Phase II is cost-reimbursable, the proposed rate is not the end of the story. Billing during the year runs on provisional rates, and after each fiscal year, the Allowable Cost and Payment clause (FAR 52.216-7) requires a final indirect cost rate proposal based on actual spending. Rates are then settled against actuals, which can lead to an incurred cost audit. A rate built from real data from the start makes that true-up far less painful. How the true-up works, with a worked example, is in Provisional Billing Rates vs. Final Rates.

How WiseCost fits

WiseCost calculates fringe, overhead, and G&A from the QuickBooks Online books you already keep, so the rate in your proposal and the rate in your ledger come from the same place.

Setup is a one-time decision about structure: each account gets a role (direct, fringe, overhead labor or non-labor, G&A, facilities, or unallowable), the same judgment your CPA would make, captured once instead of rebuilt in a spreadsheet. Unallowable costs stay out of every pool, and because labor is posted from approved timesheets, the base under each rate reflects hours people actually worked.

For the proposal itself, the Indirect Rate report shows each pool and base account by account, and downloads as an Excel workbook with live formulas and the transactions behind every rate: the backup a reviewer asks for. Saved reports keep the numbers exactly as generated, so months later you can show what supported the proposal. For the mechanics of pools and bases, see How to Calculate Indirect Rates in QuickBooks Online.

The rate you propose, and later your provisional billing rates, stay a decision for you and your CPA. WiseCost provides the actuals behind it.

FAQ

Use what the books actually show for the period available, and document any projections as separate, explicit assumptions. A rate that is clearly sourced is easier to defend than one copied from a rule of thumb.

In practice, yes. Most SBIR agencies call profit a fee. NIH describes it as not a cost, usable for any purpose, and NIH and DOE allow up to 7% of total costs on SBIR and STTR awards. Check the specific solicitation for its limit.

No. The SBA's own guidance warns against using another company's or a university's rate, since it will not reflect the costs of the business proposing it, and cannot be defended in a review.

No. Unallowable costs have to be identified and kept out of costs charged to the government. Keep them in separate accounts from the start.

The Bottom Line

An indirect rate is simple arithmetic, but a defensible one is a record-keeping habit. Build it from actual books, keep the structure consistent between the proposal and the ledger, document every assumption, and resist the pressure to shave it. A Phase II budget built this way protects the company's margin and holds up when a reviewer asks how the number was reached.

You can run our free DCAA Readiness Self-Assessment to check whether your books can support a rate review, or book a demo to see your own fringe, overhead, and G&A rates calculated from QuickBooks Online.

Official Sources

Deriving your own indirect rate and the fee: SBA, Accounting and Finance Tutorial 1
Accounting expectations and rate review in the pre-award survey: SBA, Accounting and Finance Tutorial 2
NIH SBIR/STTR fee: NIAID, SBIR performance standards and fee guidance
DOE SBIR/STTR fee: DOE PAMS budget help
Allowable Cost and Payment clause: FAR 52.216-7