7 Easy Steps to Calculate Your Charge-Out Rate
Calculating the right charge-out rate is a key part of creating a successful business.
Choosing what to charge can mean the difference between a profitable business and one that won’t generate the returns you need.
But don’t let that scare you!
You don’t need to be a mathematical genius to set your rates.
You just need the right formula to follow.
This will help you to create a rate that is in line with others in your industry, will allow you to pay yourself what you want, cover your costs and still have some left over.
So, let’s look at why you need to get the rate right and the 7 steps you need to follow when setting your charge-out rate.
Why The Rate Is So Important
Your charge-out rate is about more than making sure your business is profitable, though that is an important component! It is also about the perception that your customers have of you and your business.
Set your rates too cheap and they may question the quality of your work. Make them too expensive and they will move onto one of your competitors. Striking a balance in the middle will give your customers confidence in your workmanship and will ensure they feel like they are getting value for money.
Remember, you aren’t simply selling an hour of your time. You are actually selling all those years of skill and experience that you have accumulated. You are the expert and you deserve to be paid what you are worth.
Think About Your Competitors
We know you want to build your own brand and reputation, and that is great. But, when setting your charge out rate, you need to do a little bit of research into what others in your industry are currently charging. This will help you to set your rates in line with theirs and remain competitive.
Even if you are new to the market, don’t feel as though you need to be cheaper than all the other trades in your niche. Checking out your competitors is a research exercise, not an undercutting one.
Your customers will be willing to pay for your expertise and the quality service you will be offering them. Ideally, you want to charge as much as you can, while still pricing realistically and in line with others offering similar services.
Alright, now that we have those aspects covered off, let’s look at the 7 steps you can follow to set your charge-out rate.
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Step 1: Decide Your Desired Annual Income
How much would you like to earn this year? The answer is probably $1 million, right? But let’s be realistic about the amount you could actually earn.
If you are struggling to come up with a number, think about how much you would like to earn in a month and then multiply this by 12 to come up with an annual figure. At this stage, it only needs to be a ballpark figure.
For the sake of this article, we are going to choose a figure of $75k.
Step 2: Work Out Your Chargeable Hours
While you might plan to work 40 hours a week, not all of those 40 hours will be chargeable. There will still be all the other tasks that you normally tackle in a working week to factor in. These include things like:
Administration and answering emails
Communicating with your customers
Handling your finances - generating quotes, sending invoices and reconciling payments
Attending meetings
Managing your jobs and employees
Make an estimate of how many non-chargeable hours you would have in a week and subtract that from your 40-hour maximum. If you allow 2 hours a day to get these things done, you will be left with 30 chargeable hours in a week.
You also have to be conscious that you won’t work all 52 weeks of the year. So, let’s say you take 4 weeks of holiday and 2 weeks of sick leave. That leaves you with 46 working weeks in the year and annual chargeable hours of 1380.
Step 3: How Much Do You Need To Pay Yourself?
Now that we know how many hours you can realistically invoice out, it’s time to start building your hourly rate. We’ll start with the most important part - paying yourself.
Using the figure of a $75k desired salary and dividing it by the 1380 chargeable hours you have available, you would need to charge at least $54.35 an hour.
Now, let’s add in the other aspects.
Step 4: Factor In Your Costs
Every trade business will have overheads to factor in. These are the costs you will need to pay associated with your business. They can include:
Vehicle costs
Tools
Rent
Power
Payroll
Internet/Mobile phone
Repairs
Taxes
You want to sit down and list out all your overheads to ensure you capture the cost of everything. For this article, let’s just say your overheads would cost $50,000 annually.
Step 5: Find Your Break-Even Point
You don’t want your business costs to eat into your desired income, so let’s add those costs to what you are going to pay yourself and discover the minimum hourly rate you will need to charge to simply break even.
We’ll divide the $50,000 of overheads by your 1380 annual billable hours. That means you will need to factor in a further $36.23 an hour. Add that to the $54.35 you need to charge to pay yourself and your minimum charge-out rate has to be at least $90.58.
But we aren’t going to stop there.
Step 6: Allow For Business Growth
In order to build a successful business, you need to factor in a profit margin which will allow for business growth. If you add that little bit extra to your rates, you will have the funds for marketing, updating equipment, unexpected expenses, and all those other things needed to grow a business.
Let’s allow a 15% buffer for your profit margin. So, we’ll add 15% to the $90.58 break-even rate and you will have a final charge-out rate of $104.17.
Step 7: Finalise Your Rate
Now that you know what you should be charging to cover your costs, pay yourself a good income, and allow a buffer for profit, it is time to set your actual charge-out rate. Compare the figure you calculated against what your competitors are charging and see if your figure is realistic.
Don’t be afraid to increase your figure if that’s what the market calls for. Just be a little wary of moving it down as this will cut into your profit margin and what you are able to pay yourself. If you find your figure is too high, examine your overheads to see if there is anything you can do more cost effectively.
Help Never Hurts
Remember, that you can always ask for help to make sure you get your charge-out rate right. It can be hard to move that rate once your customers are used to paying it. So, getting your initial rate correct will help you in the long run.
While you don’t need to be a mathematical genius to work out your own charge-out rate, having your accountant help you with this exercise will give you their expert opinion. They may also be able to spot things you hadn’t thought about or offer you better strategies to maximise your profits.
If you would like some help setting your charge-out rate, then we’d love to help you here at Figuration. Reach out to the team today.