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A business wouldn’t be a healthy business for long if it didn’t yield profit.
But in the agency and professional services world, staying profitable is much more of a balancing act than in other industries.
Many agencies struggle with monitoring and managing profitability—and it’s to be expected. As an agency, you need to find the perfect price point at which you will score that potential new deal and see profit from it, too. While keeping your cash flow positive, you also need to optimally utilize your staff. Don’t forget to factor in your fixed and variable expenses. As said: balance is key.
That’s why, for the sake of your agency’s profitability, it’s key to determine how much you should charge for your agency services. Luckily, there are a few methods out there to calculate your hourly rates. We bring you the simplest formula, applicable to most agencies.
What to Consider When Determining Hourly Rates for Your Agency Services
1. Find Out What Your Actual Utilization Rates Are
Agency employees generally work an average of 120 hours per month, which totals to 1,440 hours a year. This includes vacations, daily breaks, sick leave, training and education, etc. If your agency’s realistic utilization per employee is 75% per year, consider it a great result.
2. Start Treating Your Non-billable Hours As Overhead
Overhead is more than meets the eye. Some typical fixed overhead costs for your agency are:
Office space rent
Interest on mortgage payments
Still, overhead costs are not only fixed costs—they’re all your agency’s non-billable costs, too. How so? Because all those non-billable hours are necessary for your agency to function, deliver better services, and grow. Agencies and service providers need to view non-billable costs (variable overhead) such as the following as investments:
Marketing and sales activities
Event organization and networking
Training and education
Read more about how to calculate overhead costs.
How to Calculate Hourly Rates for Your Agency
In order for a company to be profitable, a worker must cover the cost of his annual salary, times three. This is popularly called one salary for you, one salary for the company (overhead), and one salary for the boss (profit). The fact is, agencies have a lot of hours that are non-billable, which still need to be covered. All these hours that add up should be covered by the so called Times Three Model.
A rule of thumb is that your pure income should be divided as follows:
25% fixed overhead (offices, bookkeeping, education…)
Example: An employee’s gross monthly salary is EUR 2,000. Annually, that costs the employer EUR 24,000, i.e. the company must earn three times more, which totals to EUR 72,000.
So what is covered by those EUR 72,000 per annum?
The employee’s salary
Fixed overhead costs
Profit that remains to the agency
When we divide those EUR 72,000 by 1,440 effective hours per year, we come to the amount of EUR 50 per hour. That means that in this case, EUR 50 is the hourly rate you need to charge your clients for this employee’s work if you want to properly cover all your expenses and make a profit.
We ended up terminating contracts with two of our oldest clients after only a few months of using Productive. We thought that we were at least at zero with them, or that we had some small earnings, but it turned out that we were losing money because the money they paid us did not cover salaries, fixed overhead per hour, and variable overhead per hour.
The Most Difficult Number to Calculate: Variable Overhead
Many agency directors and project managers find it challenging to explain the importance of tracking time to their employees. When you precisely track billable and non-billable hours, you’re able to identify that most non-billable hours are actually an investment for your business. Without tracking time, you can’t expect to have an accurate picture of your agency’s profitability or know how to adjust your service rates per client, project, or employee.
How to Get an Accurate View of Your Agency’s Profitability in Productive
Profitability reports in Productive include your overhead and employee cost rates on top of other project data, giving you realistic margins easily. Here’s a quick breakdown on how to view your agency’s profitability in the tool:
1. Add all your employees and their salaries into Productive.
2. Add in all your clients and projects, including how much they pay you for your services (choose from different options: fixed monthly rates, monthly hourly rates, fixed rates).
3. Add your fixed and variable overhead costs into Productive.
4. After that, your employees need to track their time (on a daily basis, ideally), including how much they worked on which project.
5. As a manager, you’ll determine whether these hours were billable or non-billable.
6. Productive automatically calculates the profitability of each project and client and tells you what the cost of overhead (fixed + variable) is, per hour. It also calculates overhead per working hour, per project, and factors it in— thus giving you your profit in real time.
Read more on building profitability reports.