How to Determine Your Hourly Fees

By Randall Orser | Small Business

As an entrepreneur, are you concerned about whether your hourly fees are enough to cover your own salary, your expenses and are enough to secure a reasonable profit? If so, don’t despair. A number of entrepreneurs and small businesses have difficulty determining their hourly charges. Most have these issues when their new business venture first gets off the ground. Only later do they find out that their hourly charges aren’t enough. As such, it’s imperative to clearly define your enterprise’s hourly fees. This involves taking steps to ensure your hourly fees not only cover your salary, but that they cover your direct expenses, indirect expenses and provide a profit. So, where to begin?

A simple calculation to determine hourly fees

The calculation to determine hourly charges is quite simple. Hourly charges must account or the entrepreneur’s salary, their direct expenses, their overhead and their profit. When looking to determine your hourly salary, think of the salary you would be paid if you were an employee of a company. Next, your direct expenses and overhead must be accounted for within your hourly charges. Finally, you’re in business to make a profit. Don’t forget about the importance of securing the profit you’ll need to finance your enterprise’s future growth. It’s never enough to just cover your salary and expenses. You must account for profit in order to secure your company’s future. That profit comes from adding your hourly salary, direct expenses & overhead and dividing this total by your desired profit. We’ll provide the calculation below and then analyze each portion of the calculation in detain.

Calculation: (salary + direct expenses + {overhead or “indirect expenses”}) / profit

Coming up with your hourly salary

Don’t shy away from your hourly salary. If you’ve decided to move forward with your own business, then you’re well within your right to have the same salary, if not more, than you would if you were working for another company. This may require you to research your given profession. Concentrate on defining your hourly salary relative to your experience, where you live and where your customers will be located. Again, it might require some analysis, but you should have plenty of information at your disposal.

Understanding the difference between direct & indirect expenses

Determining your hourly fee means you must understand the difference between direct and indirect expenses and how both play a role in your enterprise’s cost structure. First, direct expenses are those expenditures that go directly to a specific job, product or service. In essence, these expenses include the raw material, parts and labour that cover the production of a given product or the work involved in providing a given service. Indirect expenses are those expenses that are seen as above and beyond a company’s direct expenses. These would include those costs pertaining to gas, equipment and car maintenance, taxes, insurance and other miscellaneous support costs. Indirect expenses are expenses that can’t be attributed to any one product or customer, but who are still an essential part of running a business.

  • Direct expenses: Expenditures that go directly to a specific job, product or service.
  • Indirect expenses: Support expenses that can’t be attributed to a specific job or product, but who are essential in running a business.

The Role of Overhead

Overhead essentially summarizes the company’s indirect expenses. These overhead expenses pertain to those support expenses that are an essential part of the company’s operations. As an entrepreneur, you’re likely just concerned with covering your own time. However, as your company grows, you may need to hire employees. Their salary will become a part of your company’s overhead, as they fall under those indirect expenses that are an essential part of managing your business. The easiest way to calculate a company’s overhead is to take indirect expenses and divide them by direct expenses. Most companies will track their expenditures over a given period. Some may track expenses by week, while others will focus on monthly or quarterly periods. In this case, it really depends upon the size of the enterprise and the fluctuations in those expenses. Small companies have more flexibility in tracking their overhead because they can immediately determine the impact of any minor changes. Larger enterprises typically review their overhead over a given quarter or year. The calculation for overhead rate is shown below.

Overhead rate = indirect expenses / direct expenses

The key is to determine your overhead rate and then use that rate to determine your indirect expenses for each hour charged to customers. This simply involves taking the overhead rate and multiplying it by your direct expenses. Why use overhead when you can simply track indirect expenses? Well, the fact is, as your enterprise grows, you’ll have to track your overhead more closely. Gradually, your overhead will likely level out and become more consistent over time.

The importance of profit

Never forget the importance of securing a profit within your hourly fee. Profit finances expansion and secures your enterprise’s long-term future. Most entrepreneurs simply cover salary and expenses. Therefore, define your enterprise’s profit and be sure to include that profit within the fees you charge your customers.

An example of working out the hourly fee

Let’s assume you work 50 hours a week and that you’ve defined your hourly salary to be $50.00. In addition, you’ve tracked your direct and indirect expenses over a period of one week. Your direct expenses total $3,000.00, while your indirect expenses total $1,000.00. Your direct expenses would be the $3,000.00 divided by 50 hours, or $60.00 an hour. Your overhead rate would be your indirect expenses of $1,000.00 divided by your direct expenses of $3,000.00. This would give you an overhead rate of .33 or 33%. Now, you could just use your indirect expenses of $1,000.00 and divide it by your 50 hours per week. This would give you $20.00 an hour in indirect expenses. Or, you could use your overhead rate of .33 and multiply it by your direct expenses, which would give you $990.00 of indirect expenses, or $19.80 for every hour charged. For this example, we’ll stick with the $20.00 an hour as summarized by our indirect expenses.

  • Salary: $50.00 an hour
  • Direct expenses: $60.00 an hour
  • Overhead or indirect expenses: $20.00 an hour
  • Profit: 20%

Calculation: (salary + direct expenses + {overhead or “indirect expenses”}) / profit

($50.00 + $60.00 + $20.00) = $130.00 / .80 = $162.50

In this case, you should charge your customers $162.50 an hour.

Now, all of this may seem confusing, but the basic approach is to determine your salary, add your direct and indirect expenses and then determine your profit. Be comfortable with tracking your enterprise’s overhead as you will likely be hiring some help in the future. By tracking overhead, you’ll become more comfortable with how it impacts your hourly fees. If it’s simpler to track your indirect expenses at the beginning, then do so. However, be cognizant of the fact that as your enterprise grows, you’ll have to enact strategies to mitigate your expenditures, and that means to reduce your company’s overhead.

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