Use Bill Rate to calculate costs and profitability
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Bill rate is the rate used to bill your customers. Bill rate takes profitability margin and utilization into account. When a project is completed on budget, you know your profit margin has been met.
When you set your bill rates, consider the following:
What’s the cost involved in doing the work?
This includes staff salaries and benefits, and overhead costs of non-billable people, rent, and other operational expenses.
What's the utilization goal of the organization?
Work can be divided between direct labor (project work that clients pay for) and indirect labor (work that’s considered overhead, or work in-between clients’ projects). Utilization is the percentage of work hours that are considered direct labor.
For example, one person has 2080 work hours within one year (capacity). If they work 1200 direct labor hours on client projects, the utilization for that person is around 58% (1200/2080). For an organization, you can calculate the capacity is for a group, and then define what percentage is the target utilization.
Utilization differs per organization, but it’s typically in the range of 50% – 75%. Higher than 75% may be unhealthy for an organization over a long period of time.
What's the profitability goal?
If everything runs according to plan, what’s the profit margin that the organization is aiming for? This also differs across organizations but is typically in the 15%-25% range.
Let’s say an employee has $80,000 salary, $20,000 in benefits, and another $50,000 in overhead and operational expenses. The total cost for that person is $150,000 per year. If the utilization goal is 58%, that cost needs to meet with the 1200 hours that this person is likely to work on client projects within the year. This equals a rate of $125 ($150,000/1200). If the company’s goal is to earn a 20% profit margin, you need a bill rate of approximately $155 per hour to cover their costs and meet your profit goal.
This is called a fully burdened rate. When you know the true cost per production hour for each team member, you can calculate exactly how much you need to charge per hour for that person to meet your gross profit goals on the projects. Budget status show if you’re below, meeting, or over your profit goal.
One way to calculate a bill rate is to use a pricing multiplier. Start with the base salary of an employee, $80,000 per year. Divide that by the number of work hours in a year, which is about 2080. This results in an hourly rate of around $38.50. ($80,000/2080).
A typical pricing multiplier is between three and five. So, using a multiplier of four results in a Bill Rate of $154 (4 x $38.50). Multipliers vary greatly and depend on your industry. Research what multiplier makes the most sense for your team.
Labor expenses and overhead expenses change over time. Recalculate this rate once or twice a year to make sure it’s current and adjust the bill rates for new projects as needed.
Calculate estimated project costs
When presenting your clients with a price for your work, base your estimate and calculations on this external bill rate. Figure out how much time it would take to complete the work and multiply that by the hourly rate. For example, if it takes eight weeks (320 hours) for one person at $150/h to complete the work, then the cost for that work is $48,000 (320 x $150).
It may be better to communicate this to the client as a fixed bid and not to divulge the hourly rate calculations that went into it. Otherwise, it can lead to situations where you’re negotiating around every hour, rather than the value of the work performed. Even when project durations are unpredictable, as in software development work for example, you can still calculate in blocks of time, and with an upper budget limit.
Set up your project budget in Resource Management
Fixed Bid Projects
For a fixed bid project, you bid to complete a defined set of work for a certain amount of money. Your budget is the price you charge the client.
For a retainer, the client pays a fee for a set amount of work, but the scope isn’t typically defined upfront. There may be a not-to-exceed agreement for the budget. With retainers, the budget is dependent on how you want to break up the retainer.
For example, it could be a series of one-month projects or phases or a year-long project. Read more about setting up retainer projects here.
Time and Materials
For Time and Materials projects, you get paid for actual hours worked. You can leave the budget blank and simply keep track of incurred fees. You can also enter a target amount or the maximum agreed-upon amount. For Time and Material projects, you might need to adjust bill rates to reflect the agreed-upon markup for worked hours.