In last week’s post, I talked about the hourly-rate payment model, and how to choose a rate that actually covers your costs. We also talked about the two main variables that affect that rate: expenses and total time.
We went in-depth into expenses, both billable an unbillable, and how you need to make sure your fee is taking those into account.
This week we’ll do the same, but for total time.
Total Time
Total time can also be split into billable and unbillable hours. Time spent on doing tasks such as your weekly accounting paperwork, or backing up your computer, would be unbillable.
However, tasks that are specifically done just for one project can be billable. I say can, because it’s not always straightforward.
It’s not impossible to bill for “unseen” hours—lawyers do this all the time. But lawyers do almost ALL their work without the client present. If, however, your business is of the type that does most of its work in front of the client, then billing for unseen hours becomes a little more difficult. The customer is likely to question those extra hours.
That’s why businesses that do work on site often cover those costs by building them into their hourly rate.
Think back to Wally’s example from last week’s article.
A client renovated his store and hired Wally to move all the existing computers to the new counter on the other side of the store. It took Wally 4 hours on site to complete the job.
Wally also spent a number of other hours on the project.
- Time spent in initial client meeting: 1 hr
- Time spent travelling to site and home again for meeting: 1 hr
- Time spent preparing plan/quote/specs/invoice 1 hr
- Time spent travelling to site and home on day work was done: 1 hr
The 4 hours Wally spent on site are clearly billable hours. The other 4 hours, however, would typically be seen as unbillable. The initial meeting could be treated as billable (the client was with Wally, so it’s clear to the client that Wally spent that hour working on the project). However, clients often aren’t happy if you charge them for an initial consultation (unless you make it clear beforehand that the consultation has a fee—but that’s often a turn off for potential clients).
So generally speaking, those extra 4 hours would be considered unbillable, and, like unbillable expenses, you need to cover the cost. Again, that is typically done by marking up your hourly rate.
I often see self-employed people who simply absorb the unbillable hours—they don’t charge them to the customer, and just accept them as a cost of doing business. You can do it that way, but your profit will be affected, negatively.
The total time it takes to finish a project is a type of expense—for every hour you work, you have to pay yourself. Think of it this way—if you had employees, and they did the work, you would pay them a wage, so why wouldn’t you pay yourself if you do the work?
But many self-employed people don’t think of it this way. They treat those extra hours as unbillable.
But they are an expense like any other, and you need to get paid for them.
Your hourly rate
How much to increase your rate so that it covers both your expenses and your total time depends on your own particular situation. One approach is to estimate all the total unbillable expenses and total unbillable time you will incur in one year, then add in your desired yearly profit. You then divide the result by the number of working hours in a year.
The formula goes something like this.
(Yearly expenses + yearly unbillable time + yearly desired profit) / number of work hours per year = hourly rate
Sample:
Let’s assume you plan on working 48 weeks per year, for 40 hours per week.
48 x 40 = 1920 total hours per year
Let’s also assume your yearly expenses are estimated to be $18,000, and you want to make $70,000 in profit per year.
($18,000 + $70,000) / 1920 = $45.83
To be honest, a lot of people just mark their hourly rate up by a certain percent, say 5% or 10%. This certainly makes the math easier, but you run the risk of not marking up your rate enough. By taking the time to accurately calculate your total yearly costs, you can come up with a markup amount that you know is going to cover your unbillables.
Of course, this formula depends on you having a good idea of how many unbillable hours you would be spending per project, and how much your expenses will be. That often comes with experience. Many people tweak their hourly rate over the first few years of their business as they get a better handle on what those two variables will actually be.
The bottom line
All of this boils down to one main principle: your hourly rate is not just based on your desired profit; it must take into account all your expenses and time.
And there is even more to this topic than what we’ve covered. For example, you have to pay taxes, and that will eat into your profit—but that’s a topic for another article!
