Cost Center Strategic Planning For Small Business Service Contractors

A growing small enterprise can enhance competitive rate development and cost management by effective cost center utilization in federal government contracting.

A cost center is a single, pricing, accounting, and billing entity within a company, organized for a group of business lines and clients with close similarities for technical and management purposes. It has its own unique overhead rate and houses the projected direct cost labor dollar base and associated expenses for that base.

A cost center is also a financial consistency template that runs from long range planning through proposal pricing, accounting, billing and closeout for the contracts it houses.  It is the way DCAA and contracting officers view major aspects of your business and your rates for that business.

INITIAL COST CENTER EXPERIENCE

Enterprises that have not experienced federal government contracting typically base their initial proposals and bid submissions to the government on their commercial quotation approach and related market rates.  This usually involves a single company cost center approach with both government and commercial work together at the general ledger level. 

When the company gains experience in government contracting through audit exposure during proposal fact finding/negotiations, as well as accounting and billing, it becomes apparent that government cost accounting standards (CAS), job cost accounting and cost management at lower levels than the commercial general ledger are necessary to succeed.  At that point a business system to support the new requirements begins to take shape. 

The below graphic contains a typical graphic overview of the processes necessary.

PLEASE CLICK ON IMAGE TO ENLARGE

Note the long range planning and cost center blocks in the graphic.  The remainder of this article will focus on those two elements of the company business process. 
 

GROWING INTO MULTIPLE COST CENTERS

The time to consider separating government from commercial work and/or establishing new cost centers for bidding, accounting and billing purposes is when the enterprise is generating a long range marketing plan to determine rates for bidding new long term contracts.

The location of the work (both geographic location and whether performance is in or out of a government facility, its duration, skill set requirements, government-mandated fringe benefits for workers and the competition are all factors to consider).

The government will not question your setting up a new cost center and projecting a direct cost business base within it together with associated expenses and the resultant forward pricing rates.  The reality you must remember is that the business in the cost center must materialize as a contributor to the company G&A base for the firm’s rates to remain consistent.   DCAA will check the math during a proposal audit.  You must make the projections happen to succeed if you win the work.  Please see the following article for the details on these relationships:

Establishing FAR and CAS Compliance

Setting up a new cost center retroactively for contracts that are already in process with pricing, job cost and billing records supported elsewhere in the plan, and the business system is extremely difficult.  Looking ahead during the bid process pays big dividends.

PROBABLILITY FACTORS IN COST CENTER FORECASTS

Probability factors reflect the likelihood of contract awards.

Place into the projected base for a cost center only that amount of forecasted direct cost base deemed likely to occur and then market and manage to make your forecast happen.  If major projects in the forecasted business do not materialize your actual, realized base will be too low and your overhead rates will go up during cost center operation unless expenses are cut. That means higher bidding and billing rates to your customers.

Probability factors are usually applied by forecasting the direct dollar labor content for the job in dollars and factoring it based on marketing intelligence relative to competition, the company capability statement, past performance with the agency and how well the firm is known to the customer.  Proper modeling of probability factors avoids unrealistic cost proposals and cost overruns under contracts while permitting flexibility in risk taking to beat the competition. Please see the below article for further details on this practice:

Provisional Indirect rates

SUMMARY

Projects performed in government facilities may require a separate cost center, since many of the associated expenses for such operations are born by the government, who in turn expects a lower overhead rate as a result.

For accounting purposes cost centers usually have individual subsidiary ledgers, balance sheets and profit and loss statements. They are summarized monthly to a company total. Each cost center must have job cost accounting for the contracts residing there and a cost-center-unique overhead rate. 

The sum of the direct and indirect costs in the company cost centers forms the G&A base to which corporate level expenses are applied when calculating the G&A rate that is further applied to all projects residing in all centers after labor, labor overhead, material and other direct costs (travel or like expenses) have been summed.

Assuming your competition pays a generally similar labor rate to employees as you do and that fringe costs about the same for everyone, then cost center overhead, coupled with the company G&A rate, are often what wins and loses price evaluations during source selection. 

For more on cost centers and attendant business system considerations, please see the PRICING, BUSINESS SYSTEMS, FINANCE & ACCOUNTING section of the free book offered at this site as well as the long range plan and estimating and pricing examples in Appendices A and B to the book.