Overhead Recovery Analysis - Hourly Rate Calculator
Steps to Controlling your Labor
Do you have staff that are responsible for generating revenue?
Then this hourly rate calculator is a must have tool for calculating your predetermined overhead rate.
Using this hourly rate calculator, you are able to both monitor your labor and come up with some ideas for competitive pricing for your service. It is well know that if you can control and monitor your labor you can ultimately control and monitor your profitability in a service based business. This is also a ideal method of employee evaluation making sure that each nominated employee 'pulls' in their quota of revenue for the business.
This is true in any labor intensive business operation, involving anyone who is responsible for generating revenue. These might be service technicians, mechanics, consultants, virtually anyone whose responsibility is trading hours for dollars. You do this by knowing your predetermined overhead rate, and you can do this using the hourly rate calculator tool.
If your business involves the purchase of materials your profit on your materials should look after itself as you should be putting sufficient mark up/profit on materials anyway. So for the purposes of these examples we will assume that all materials are already looked after with a healthy profit margin.
The calculations below therefore only involve labor and are centered around discovering your predetermined overhead rate for a service based business using a fictitious automotive repair shop as a working example for our hourly rate calculator.
Using this process you can also accurately calculate a break-even hourly rate for any service based business. You could then add on your required gross margin depending on which pricing strategies have been adopted for your business.
You could also use this to calculate an predetermined overhead rate for a consulting services for example. Again this overhead recovery analysis is used for labor rates only, no materials are involved in this calculation process. This great tool will not only show you how to calculate productivity (in terms of revenue generated), but also how this is measured in terms of productivity and employee evaluation.
In the following examples we have used a automotive repair workshop to demonstrate how to use the hourly rate calculator
How to use the Overhead Recovery Analysis - Hourly Rate Calculator
Step 1. Calculating the Available Hours
The above numbers will need to be adjusted for your particular country or region and the required adjustments made to this table. However the principle of calculating the available hours remains the same. Make also the necessary adjustments to the allocation of training time and admin (paperwork) time, this will vary for each category of employee.
All of these time deductions are always to be worst case scenarios, if these times are reduced or in fact not actually deducted then profitability will increase assuming the productivity is as predicted (budgeted) this will be allowed for in the hourly rate calculator.
Step 2. (Establish Total Costs for the Operation)
You need of course to establish your total costs for the business operation (wringing wet as I call it). These would be for the particular business unit in question, or, if your business is only a service based business (see above) then this would be the total costs for the entire business.
All costs should be totalled including; wages (and on-costs), vehicles (maintenance costs, fuel, registration), office rent/lease costs, in other words all the expenses that would typically appear on the profit & loss report. Do not include any capital purchases here (these should not be appearing on the P&L anyway).
Make sure that you have all the costs associated with the running of this business (or business unit if a division of a larger company).
For our example for the hourly rate calculator lets assume that the we have a small automotive repair shop business and the total operating costs are budgeted to be $550,000 per year.
Step 3. Decide on Who are the Revenue Generators
The next step is to decide which people in the business will be the revenue generators. Before we get into this some explanation is necessary here ...
Productivity expectation (ranging from 0% to 100%) is the amount of billable time that is expected (and actually) produced each period (monthly/weekly/daily) by each person in the operation.
So let's take our simple example where we have a small automotive repair shop ...
We have Mark:
We also have Maggie:
And we have Danny:
Finally (and most importantly) we have the in-house mechanics:
These are all full time workers, repairing and servicing the motor vehicles as they come in. It is natural therefore to assume that they will be productive (producing billable time) for 100% of their working week of 40 hours.
So we have Mark (Owner) at 30%, Maggie (Admin) at 0%, Danny (Supervisor) at 50% and the 4 Mechanics (Grant, Joe, Damian and Nick) all at 100%.
Of course these percentage figures are estimates or budgets that are set along with all the other budgets at the beginning of the financial year. The achievement of these percentages (or correctly termed Key Performance Indicators or KPI's) are essential to achieving the required profitability for the business operation based on the original budget numbers.
We are also assuming here also that the level of sales required for the business in maintained, otherwise the required adjustments to the business will need to be carried out to correct this.
Step 4. Adjusting the Recoveries
The recovery percentages listed above are in fact not usually achievable in reality, and a level of adjustment (for day to day activities) is required here as follows:
For example there is an element of downtime always for such things as: health breaks, paperwork time, coffee/tea breaks, and lunch etc. So the final adjustment could be for our example business:
Mark (Owner) now 25%, Maggie (Admin) still 0%, Danny (Supervisor) 40%, the four mechanics now 90%. Again we are assuming a constant flow of business is maintained here.
Step 5. Allocating the Recoveries
Having established the final percentage recoveries in step 4 it is time now to calculate the number of hours available for billing in the year.
Lets assume (for simplicity) that the final hours available (1,544 hours) from Step 1 is in fact correct for all staff members. It may be tweaked in reality as some employees may not have certain allocations of time deducted (i.e. training time or admin time etc.)
So for each of our staff we have a total (hours available) of 1,544 hours. And our staff percentage recoveries were:
Mark (Owner) 25%, Maggie (Admin) 0%, Danny (Supervisor) 40%, and 4 Mechanics 90%.
We now calculate the available (expected billable) hours as follows:
Grant, Mechanic 1
Joe, Mechanic 2
Damian, Mechanic 2
Nick, Mechanic 4
Therefore total available hours for billing = 6,564 hours
(Maggie does not contribute to this process as her recovery is 0%)
Step 6. Calculating the Overhead Recovery Rate
To calculate the overhead recovery rate (or break even hourly rate) we need the total costs for the business per year and the total amount of available (billable) time for the year for everyone added together.
We know form Step 2 that our operational costs for the year are $550,000 and from Step 5 that the total available (billable) time for the year is 6,564 hours.
To calculate the overhead recovery rate we divide the total costs for the business - $550,000 by the total available (billable) hours 6,564. The overhead recovery rate is therefore = $83.79 per hour. Remember that this is just the break even hourly rate and a margin needs to be added to this to make the selling hourly rate price.
So if your sell price for your hourly rate was $100.00 per hour using our example your gross margin would be $100.00 - $83.79 = $16.21 (16.21%).
Of course there are variables in business and employee productivity, wages and levels of work (sales coming in) all contribute to this process. However if you set this up as I have described and measure your metrics on a regular (suggest weekly) basis then you will be on top of the most difficult of all factors to manage - labor, using the hourly rate calculator to calculate a predetermined overhead rate.
If your sell price for labor is fixed for a given period (and your customers know this) then you MUST check your overhead recovery rate rate on a regular basis! Should your employees not be producing at the (% recovery) rates that you have set them (see above Step 4 & 5) then your profitability will decrease (and your predetermined overhead rate goes up). Conversely if your employees produce a higher recovery % rate then your predetermined overhead rate will go down and your profit will increase! This is all assuming that your sell price is fixed.
Sounds complex I know but once you get used to using these formulas and calculations and monitoring your employees performance you are well on the way to profitably managing your labor!
If you would like an Excel spreadsheet that is all set up with these examples, formulas and calculations for you to start working with (or of course you can change all the data to suit your own business) you can buy this hourly rate calculator by clicking on the link below.
This is a great tool to use to set up your labor budget controls and profitability, and you can fully customize this tool for any business!
How to Use the Overhead Recovery Analysis - Hourly Rate Calculator
Purchase Price - $9.95 (USD)
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