Most small businesses provide a service where they charge by the hour. Unfortunately, many new small business owners under estimate what they ought to charge per hour in order to make the amount of money they desire.
Hourly Service Financials
If you provide services for which you will charge clients by the hour, you need to ensure that your hourly rates will provide your overall business with profit. Most new business owners forget to consider added costs for labor described below:
Employer Taxes: As an employee you know that your paycheck gets reduced for income taxes, social security and other withholding. As an employer, you pay an additional FICA tax and/or self-employment tax on top of all of those other payroll taxes. In most cases, this extra amount is approximately 6.2%.
Benefits: Many employees expect additional benefits to be added to their paycheck for health insurance, disability, and other items. In today’s market, health insurance may cost an average of $1,000 per month depending on the age of your employee. If your employee earns $20/hour, this benefit will be an additional 30% of their compensation.
Efficiency: Most employees will not be 100% productive. They will need to spend time on administrative work or you may not have enough work for each employee to be 100% billable. In fact, the average I use for financial planning is a billable percentage of 50%. This means that you will only be able to charge for 50% of their labor. This efficiency rate or billable rate varies quite a bit for each industry, but you will need to factor this in for your business.
Management: Depending on your industry, your workers may need supervision of some sort. These managers also cost money. If your manager is managing six people, their compensation will need to be divided among the field workers six ways in order to account for their compensation.
Vacation & Holidays: We all want vacation, but seldom plan for vacation in our hourly rates. A traditional holiday schedule for most workers is 11-days per year. The average vacation time per year ranges from 10-days for entry-level employees to 20-days for veteran employees. This means that out of the 260 working days each year, an average of 26-days will be paid time off. This added time off means that you need to charge an additional 10% for this time. If you offer sick days or other time off, this percentage will be higher.
Support Overhead: Hiring people is not just about their time and benefits, its about giving your people the proper support with an office to work in (if they need an office); office supplies; computers; internet access; and any tools that your employees will need. This percentage will vary widely by company, but it is typical to have an overhead rate of 15% to 35% for most service oriented businesses.
Let’s say that the workers in your new business will be paid $20 per hour. How much should you charge your clients for their time?
Base Pay $20.00/hr
Added FICA (6.2%) $1.24/hr
Added Benefits (30%) $6.00/hr
Management ($50/6) $8.30/hr
Vacation (10%) $2.00/hr
Overhead (20%) $4.00/hr
100% Billable Hourly Cost $41.54/hr
50% Efficiency > $83.08/hr
This means that you will actually pay your workers approximately $83.08 per hour once you consider benefits and additional taxes paid by the employer. I have not yet talked about what you will charge your client.
It is customary to charge between 20% to 50% more to your clients for labor than what you pay. Labor is one of the highest risk costs in managing a business. That is why labor has a higher profit margin than most other costs.
In our example, the hourly fee for your $20/hr person may be as high as $125/hr.
Are you charging enough for your labor?