Hourly Rate Calculator - Steps to Controlling your Labor

If you can control your labor you control ultimately your profitability, especially in a service based business involving technicians or mechanics for example. 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 this explanation materials are all looked after with a healthy profit margin.

The calculations below therefore only involve labor costings not materials and are centred around overhead recovery analysis for a service based business using an automotive repair shop as a working example for our hourly rate calculator.

This process can be used also however as an hourly rate calculator for any service based business. You could use this to calculate an hourly rate for consulting services for example. Again this calculates labor rates only and no materials are involved in this calculation process.

Step 1. Calculating the Available Hours

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)

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 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

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:
The Owner he does the financials, liability reporting (tax, GST) and some bookwork, he also gets his hands dirty for some of the time and works on the floor. So lets give Mark a productivity expectation of 30% (in other words he is expected to have 30% of his time recovered), this is called producing billable time for 30% of his overall working week of 40 hours.

We also have Maggie:
Who is the office lady, she only does administration duties, collecting job card information and data entry and bookkeeping duties. She is purely therefore an overhead in the business so her productivity expectation is 0% because she does not produce any billable time.

And we have Danny:
The supervisor, whose job is to collate and sign off on the job cards produced by the mechanics, keep the mechanics trained up with the latest technology and skills and monitor work output. He also gets his hands dirty and works on the floor doing high level repairs for 50% of the time. So he is expected to have 50% of his time recovered and therefore produce billable time for 50% of his working week of 40 hours.

Finally (and most importantly) we have the in-house mechanics:

1. Grant
2. Joe
3. Damian
4. Nick

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

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

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:

Mark
= 1,544 x 25% = 386 hours

Danny
= 1,544 x 40% = 618 hours

Grant, Mechanic 1
= 1,544 x 90% = 1,390 hours

Joe, Mechanic 2
= 1,544 x 90% = 1,390 hours

Damian, Mechanic 2
= 1,544 x 90% = 1,390 hours

Nick, Mechanic 4
= 1,544 x 90% = 1,390 hours

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

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%).

Variables

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 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 (your overhead recovery rate goes up). Conversely if your employees produce a higher recovery % rate then your overhead recovery 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 you can buy this hourly rate calculator for $10.25 (USD) by clicking on the link below. Great tool to use to set up your labor budget controls for profitability and you can fully customise for your business!

See image below.

Click here to buy spreadsheet template

Overhead Recovery Template