Not sure what you should charge for your products or service? Do you worry every month how you will cover your running costs or pay your salaries? Here’s some pointers to help.
It’s essential. You need to accurately calculate your true hourly rate. Get clarity into your expenses, profit and productivity. Why? Entrepreneurs and business owners often wrestle with what to charge customers.
It’s understandable – in today’s economic climate, the bidding war is alive and well; come in too high and you lose the job; quote too low and you don’t cover your costs.
However, probably more damaging than coming in too low is not actually knowing what you should be charging. If you only use your competitors to set your pricing model, or base your prices on what youthinkyou deserve, chances are you’re hurting your business.
More than that, as a result of this vague pricing model, you’re probably paying your doctor too many visits in order to treat your sleepless nights and recurring ulcers. So, knowing what your real hourly rate is will give you more than a starting price-base; you get clarity into your costs and profit margin.
You also get insight into your productivity. Now you’re running your business less on grit and instinct, and more on strategy.
1. Cost Centres: Start here
The best way to determine your hourly rate is to break your business up into measurable portions. These are your cost centres. A cost centre could be your design team with their Mac’s and printers, your fleet of vehicles, or the machine that fills one third of your factory floor.
Cost centres also make it easier to identify and isolate variables to determine how efficient that cost centre is.
Two types of cost centres:
a) Overhead cost centres
This cost centre houses your indirect costs, basically expenses that are not directly recovered from the sale of your product or service, but are necessary to support the business. Your overhead costs are shown as the ‘expenses’ from the Income Statement, less the production salaries. There are typically many production cost centres in a business, and only one overhead cost centre.
When considering how to cover your overhead costs, you can approach it in one of two ways:
- Includeit in the hourly rate by allocating it as a percentage across each of the business’s other cost centres, or
- Excludeit in the hourly rate, and add a mark-up in your estimate.
b) Production cost centres
These are your direct costs, such as equipment, monthly maintenance and production salaries - costs directly associated with the production of a product or service that you sell.
- Machine costs: The total replacement value of a machine or computer or equipment, broken down into a per-month value.
- Maintenance costs: The monthly maintenance and service fees required to support your equipment or vehicles, plus provision to cover breakdowns or repairs.
- Labour costs: Only salaries directly associated with production, such as the machine operator and his assistant, the driver, or the designer.
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2. Productivity needs to be addressed
Once you know how many productive hours are available to process work through that cost centre, you can determine what each hour should cost.
- Weeks per year: There are 52 weeks in a year, but not every week is productive: two weeks are public holidays, and there are three weeks of annual leave, leaving 47 productive weeks in a year.
- Hours per week: With 40-hours typically available per week, most people are only productive 80% of the time, leaving 32 productive hours per week.
To calculate hours per month
To calculate the productive hours per month, take weeks per year, multiplied by hours per week, divided by 12 (months of the year). Or:
Hours per month = (weeks per year x hours per week) / 12
Note:Pay special attention to your productivity calculation; not all cost centres are as productive as the next. You might notice one cost centre only sees 30 hours of work a week instead of the assumed 47 hours.
Adjust the value in your calculation and your hourly rate will reflect a higher value. In the beginning, you may have to do some thumb-sucking to start the ball rolling, so feel free to use these values (above) as a baseline for your productive hours. Alternatively, your ERP or BOS system should show you monthly cost centre recovery so that you can adjust productivity accordingly.