In previous blogs, Is Your Labor Billing Rate Killing You? Part 1 and Part 2, we identified various issues on how to accurately calculate your labor billing rate and a variety of other issues.
At Tom Vignali CPA, Inc., these issues face numerous businesses on a daily basis and have significant impacts on profitability and the marketing potential of our clients. We have compiled this three-part series of blogs to identify and outline some basic calculations and formulas to be used in your assessments regarding establishing an accurate and marketable labor billing rate. In Part 3, we will identify some tactics that can be used to make adjustments to your calculations to ensure that your rates are accurate and fulfill the financial needs of your company. Some of our comments will be recommendations on business practice, while others will be specific to the calculations. In either case, we highly recommend that you use the calculations listed in Part 1 and Part 2, and that you make the necessary adjustments to fit what your company needs.
Here are some critical issues you need to consider:
Why Your Labor Pay Rate Is Not Your Labor Billing Rate
What you pay an employee IS NOT your labor billing rate. Your labor billing rate is based upon what you need to bill for to cover all related expenses. So, if you pay for 2,080 hours of time, but are only capable of billing for 1,205 hours, your labor costs are almost doubled just for what you are paying that employee. This does not include any employer payroll contributions, worker’s compensation, benefits, etc. Also, it does not take into consideration a much-needed contribution to G&A and profit margin. So, you labor billing rate needs to take into account the total labor costs for that employee, not just the costs for the hours being billed, as well as a contribution to G&A and profits.
Utilization Rate: How Many Hours Are You Actually Billing For?
The utilization rate is based upon how much of the available billing time you actually bill for, not the amount of time you are paying the employee for. So, if the amount of time you pay an employee annually is 2,080 hours, and you can only bill for 1,205 hours, if you actually bill for 1,205 hours, then your utilization rate would be 100%. In this example, you need to generate enough revenues by billing for 1,205 hours to cover the Labor Pay Rate for 2,080 hours! As the utilization rate decreases, what you need to charge to cover the Labor Pay Rate increases. Additionally, as the utilization rate decreases, the corresponding contributions to G&A and profits increase. Remember, the utilization rate is based upon how many available billing hours you actually bill for, NOT how many hours you are paying an employee for!
Wasted Time and Lost Time Reduce Available Billing Time
Another consideration regarding available billable time is wasted time. Previously, we made calculations regarding administrative time, travel time, etc., and we included this time into the labor costs. These are costs we are able to calculate into the labor rate. But remember, revenues are generated from available billable time, and if the available billing time is reduced by wasted time, this would have a negative impact on the rates you will need to charge. Let’s say you have 10 employees and they all show up at the shop each day for 30 minutes before you can start billing for their time, but they are all “on the clock.” The amount of paid for, unavailable billable time would be:
10 employees X 30 min per day X 5 days per week = 25 hours per week
25 hours per week X $20.00 per hour = $500 per week
$500 per week X 48.2 weeks per year = $24,100 per year
Now, this is a common example of everyone at the shop for just 30 minutes each day. Imagine if the same process occurred at the end of the day as well or if it was for 45 minutes instead of 30 minutes. We understand how important it is for management to maintain communications with their staff, but it must be scheduled in a logical manner to maximize available billing time. A few hours of wasted time each week can easily compound itself into a massive amount of lost billable time, and this becomes even worse when it occurs with numerous employees.
Even though we have made some calculations to address travel time, it is critical to make sure that you schedule travel routes in a logical fashion. Back-tracking or route overlaps are just two ways travel time could become more costly than it needs to be. Similarly, avoiding traffic congestion and high traffic times is another way some of our clients reduce travel time. Coordinating deliveries or pick-ups is another tactic some of our clients use.
There are some great technological tools which some of our clients use to make employees more efficient. Some of them allow for online estimating, billing, payments, ordering, inventory control, time tracking, GPS, etc. These tools help to reduce wasted time and assist with maximizing the available billable time.
The more you are able to bill for EVERY hour you pay an employee, the more your actual labor costs will become a direct pass through to the billable rate. Wasted time and lost time are two critical areas where a company can easily find they have to overprice their services in order to cover expenses, or can’t charge enough and find themselves operating at a loss. When you over-price your services, you can find yourself charging more than the market will bear, and you could lose market share. When you underprice your services to meet existing market rates, you could find yourself operating at a loss.
Reduction of Hours Can Impact Calculations Positively
In the calculations we have provided, we used one basic rate of pay ($20.00 per hour) and assumed that the employee would be working 40 hours per week for a full year. Reducing the hours worked per week (say from 40 to 38) or the weeks worked per year (for seasonal businesses) could reduce the overall cost for that employee, and could have a significant positive impact on your calculations.
Schedule Staff Strategically Based Upon Rate:
Strategically utilizing employees based upon their pay scale could allow you to realize a higher profit margin with regards to the employee pay scale. Using a $20.00 per hour employee to do the same work that a $15.00 per hour employee could do might have a negative impact on profitability. The strategic use of skilled employees in conjunction with their direct costs and billing rates is something that should be constantly reviewed.
Overtime Can Be Costly
A major profit-destroying issue is having to pay employees for overtime when there is no provision to bill for overtime. There is no allowance for overtime costs in the calculations provided, and if you have to pay for it, but cannot charge for it, contributions to G&A and profit margins will be seriously impacted.
Conclusion
These are just some of the issues we attempt to address with our clients who bill for labor services. Frankly, each company has needs specific to that industry, location, market and competition. Each requires a detailed analysis of all of the issues. There is no “one size fits all” solution. This is why we perform an individualized analysis of each client business we deal with.
What we do know is this: If you don’t look at all of the data, if you don’t consider all aspects of the business, employees, customers and marketplace, you could very easily miss the most critical factors necessary to calculate a profitable billing rate.
After all, the objective is to sell if for more than what it costs you!
As always, if you need immediate assistance regarding these issues, don’t hesitate to contact us at Tom Vignali CPA, Inc.
Contact Us:
Thomas W. Vignali CPA Inc.
118 Point Judith Road
Narragansett, RI 02882
T: (401) 415-0798
tom@tomvignalicpa.com
www.tomvignalicpa.com
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