The colors of money for GovCons: Understanding how every dollar works

Do you know what color your money is?  

Not its physical color, but rather how you classify each cost to your GovCon’s business. How you categorize a cost can be the difference between reimbursement and a hit to your margins. 

While the federal budget process uses “colors of money” to distinguish appropriations (e.g., O&M, R&D, Procurement), in the GovCon business operations world, we use the term more broadly to mean the categories of costs and how they’re treated under federal contracting rules. And understanding the ins and outs of those categories can help you build efficient systems that amp up your odds of sustained success. 

Let’s break down the key categories, how they work, and why they matter – plus whether each one impacts your profit directly. 

Direct costs 

Direct costs are the easiest to understand, and the most self-explanatory. They’re the dollars you can clearly tie to a specific contract or project. Think of them as the “assignable” expenses. If you can point to a single customer or contract and say, “this cost exists because of that project,” that qualifies as a direct cost. 

Common examples of direct cost may include things like: 

• Labor hours your project team spends working on the contract 

• Materials purchased specifically for a contract 

• Subcontractor costs linked to deliverables 

Why does understanding and appropriately classifying direct costs matter? Just like the name of this category is self-explanatory, you can likely guess why it matters, too: direct costs go straight onto your contract billing. 

How might direct costs impact profit? Generally, all direct costs are fully reimbursable when billed correctly under the contract, which means they should all have a positive impact on your profits. 

Indirect costs 

Indirect costs are those costs that are necessary to run the business, but not easily linked to a single contract. These costs are grouped into pools, and allocated across multiple contracts using an approved rate structure. Consideration should always be given to indirect costs through the lens of overarching operational efficiency, and this can also be an excellent opportunity to consider automating the systems and models your team uses to make financial plans, or revisiting the automation you currently have in place. 

Typical indirect cost pools might include: 

• Overhead: Costs tied to supporting contract execution, such as the facilities used by a GovCon 

• General & Administrative (G&A): These encompass company-wide costs like HR, accounting, legal, and executive salaries 

• Fringe: Employee benefits such as health insurance, payroll taxes, and paid leave 

Indirect costs matter because indirect rates are often scrutinized by the DCAA (or other auditors) and are a key part of pricing strategy. The good news is that there should be no direct profit hit if rates are calculated and billed correctly. These are recoverable in your indirect rate structure. 

Allowable vs. unallowable costs 

Under the Federal Acquisition Regulation (FAR), not every expense is recoverable from the government – even if it’s necessary for running your business. There are allowable and unallowable costs, and while it is relatively easy to understand which costs fall into which category, it’s important to familiarize yourself with the differences. A clear understanding of the categories will help prevent any unexpected financial surprises.  

• Allowable costs: Reasonable, allocable, and compliant with contract terms and FAR Part 31 

• Unallowable costs: Explicitly non-reimbursable. Examples include alcohol, bad debt, charitable donations, fines, and certain entertainment expenses 

Allowable costs are simple, and will not have any outsized impact on your financial planning. When it comes to unallowable costs, note that you can spend money on this category, but you must segregate them in your accounting system. 

When it comes to allowable costs, there is no direct profit hit, because these costs are recoverable. Unallowable costs, on the other hand, do have a direct profit hit and must be absorbed by the company.  

This is where even the most perfectly automated system or process in financial planning benefits from human intervention. Only you and your team can decide what the potential upside might be when it comes to things like charitable donations, or certain entertainment expenses, particularly when it comes to the sales and marketing side of the house. 

Beyond basic indirect costs: Bid & Proposal (B&P) costs 

Bid & Proposal (B&P) costs cover the work of pursuing new contracts, from market research all the way through to proposal writing (but nothing following the moment in time when a prospect becomes a client). Under FAR rules, B&P is treated as an indirect cost and typically allocated to G&A. This is because B&P will naturally stretch across any and all potential contracts a GovCon is considering.  

Some examples of B&P costs include things like: 

• Capture management and proposal team labor 

• Travel to prospect offices for proposal presentations 

• Printing, graphics, and proposal software utilized throughout the pitch and presentation process 

You can recover B&P costs indirectly, but only if they’re not tied to an existing contract. There is no direct profit hit if B&P costs are recovered in indirect rates. But under-recovery of G&A rates or excess spend can erode profit, so you’ll need to set realistic budgets and follow spend closely. 

Getting the word out: Marketing costs 

Costs associated with marketing are an unallowable category under FAR. This includes activities like brand advertising, sponsorships, and promotional activities aimed at general business image rather than specific proposal efforts. If there are costs related to specific efforts, your team should be looking at them through the lens of the B&P costs we discussed above. 

So, what are some examples of general marketing costs? They might look like:  

• Trade show booth space 

• Corporate advertising 

• Sponsorship of industry events 

While unallowable, marketing is still strategically important. General advertising or marketing efforts are designed to lead to increased organizational awareness and top-of-funnel interest, so these costs should be tracked with a long-term view on how the company reputation will benefit from greater awareness and engagement. 
 
Marketing is a cost center, which means these costs will be a direct profit hit. Marketing is fully company-funded, and cannot be billed to the government. For this reason, marketing should be considered through a lens of long-term organizational health. 

Planning for innovation: Independent Research and Development (IRAD) 

IRAD is research and development work a company funds internally without direct government sponsorship. The intent is to create new capabilities, improve products, or explore innovative approaches. 

A few examples of IRAD spend may include: 

• Developing a new prototype with future government application. 

• Testing emerging technologies for readiness. 

• Creating process improvements for manufacturing. 

IRAD is generally allowable as an indirect cost (often charged to overhead or G&A), provided it meets FAR and contract requirements. After all, innovation is a natural part of doing business and maintaining a healthy, competitive professional landscape. 
 
There is no direct profit hit for IRAD costs if recovered through indirect rates. However, if rates don’t fully cover IRAD spend, there’s a partial profit hit. That’s not to say GovCons should only focus on keeping IRAD costs below a certain amount, but rather that this spend should be given careful strategic consideration. 

Why all of this matters 

For GovCons, knowing the “colors” of your money comes down to three key considerations: 

• Better pricing: You can’t develop competitive rates if you don’t understand what costs go where 

• Stronger compliance: FAR compliance is non-negotiable in GovCon; accurate cost classification is a core requirement 

• Smarter decision-making: Understanding your true cost structure informs investment in growth, R&D, and capture 

With all of this in mind, there are a few things you can do today to manage your colors of money effectively, both now and in the future: 

• Use the right accounting system powered by an enterprise resource planning solution purpose-built for GovCons  

• Train your teams on what’s allowable vs. unallowable and direct vs. indirect 

• Review your cost pools regularly to ensure proper allocation 

• Audit yourself periodically before the government does 

The (literal) bottom line  

In the GovCon industry, every cost is either working for you or against you…and the difference often comes down to how you classify it. Learning how to correctly classify your costs enables you to protect your margins, price smarter, and make deliberate investments that position your business for growth.  

Learn more about how you can empower your team with the right solutions to better manage your money by connecting with a Unanet expert today.