Note: This article is written from the sign shop perspective, but is applicably to any small business where time and materials are the bottom line.

The wrong hourly rate (or “shop rate”) can be like a hidden cancer for your business.

How do I know?  Because I almost killed my sign business this way in 1995. Obviously, now that EstiMate Software is my gig, I’m not making signs anymore.  I grew up in the business, though, and ran my own shop for 8 years — so I know a thing or two about how to keep it going and what matters.

One thing I know for sure is that the wrong shop rate can kill your business.  Especially in times like these. The very worst thing you can do is work for cheap.

The obvious question here is, WHY does your hourly rate matter so damn much?  Isn’t it the cost of materials, or gas for the truck, or how little you can get away with paying your employees more important than a buck or two here or there on your shop rate? Actually… in a word… no. Your shop rate is the one thing that determines whether or not you are profitable or not, on each and every job, and in this article I’ll show you why and show you how to figure your shop rate appropriately.

Warning: this article can be scary.  You will probably find that you’re leaving money on the table you didn’t even know about – and if you haven’t done these important steps there’s a better than even chance you’ll discover that you’ve been running in the red.  One thing I’ll guarantee you right now, though, is that you’ll know, for sure, what you need to be charging your customers when you’re done reading this article and working the steps.

Stop Using Your “Calculator On The Ceiling”

Rewind to 1977.  I was eight years old, and my mother had just opened Signs Limited in our basement in Winston-Salem, NC.  For the next 14 years I watched her struggle to price her work, and manage to keep us afloat with very little cash flow.  Every time the phone would ring, and a customer would ask for a price, she would say “let me go figure that for you.”  Then she’d put the phone down, stare up at the ceiling, drum her fingers on the desk, pick the phone back up and give them a price.  I never knew where that calculator was on the ceiling, but I knew it was there because she used it every day.

Do you?

Fast forward to 1993.  I started my own shop in Asheville, NC, Ampersand Signs & Designs.  I had just come out of a job doing bookkeeping and advertising design for a local free paper, and had been making 9 bucks an hour there.  So when I started making signs, I thought “WOW! I can charge TWENTY FIVE BUCKS an hour, and make a frickin’ killing!”  I proceeded to do that and I did make a killing — of my business! Every day when I got up, I was poorer than the day before, and I didn’t know it.

That’s why this is like cancer.

We have to start really thinking like business owners, and not employees.  That’s the key to getting out of the mindset that $25 per hour is good money — it’s not.  Every minute that you run your business, whether you are actually doing work you get paid for or not, you are burning money.  And you have to recapture that in your hourly rate.

Starting to make some sense here?

One cold day in early 1996 I was reading through a whole bunch of back issues of SignCraft magazine, and I ran across a great article by Jeff Cahill called “An Accurate Hourly Rate Is The Basis For Effective Pricing.” I remember sitting up very straight as I was reading it, and when I was done I knew I had to get control of my business, or I’d lose it. This actually was the seed that started EstiMate, because once I had done this manually, I knew that quoting properly was so time consuming that I had to have a good tool to do it.  So from ’96-’99 I wrote EstiMate 1, and hopefully have contributed some value to the industry through it.  I will always tip my hat to Jeff.  Thank you, sir!

Let’s Get Down To Brass Tacks

Figuring your own shop rate is actually very straightforward.  Basically you need to gather up your overhead figures, determine how many hours you can bill in a day (this figure is way different from the number of hours you are open), set an amount of profit you’d like to achieve, and take your taxes into account.

Let’s walk through the steps.

Overhead

Your overhead is everything you spend to run your business, not including materials for your jobs.  The reason materials are not included is because they are paid for through marking up the cost on your materials when reselling to the customer, and you don’t need to recapture this money through your shop rate.  Some very good examples of overhead are:

• Employees & Payroll (I recently read a fantastic book called How to Get Rich: One of the World’s Greatest Entrepreneurs Shares His Secrets by Felix Dennis, and in his book he says some hilarious things… one of them is “Overhead walks on two legs.” Funny man!)
• Advertising / Yellow Pages
• Shop Rent or Mortgage (if you work from home include your home mortgage, because then when you move to a shop you’re already charging as if you’re in one)
• Vehicle Payments
• Subscriptions to magazines or quoting software
• Lease payments on equipment
• Office Supplies
• Telephone, electricity, water & sewer service
• etc.

Gather up all these figures, and if you are using monthly numbers multiply by 12.  This will give you your annual overhead, also known as your “nut.”  It can be pretty eye-opening to see what it actually costs you to run your business — and at this point you should start to see why this hourly rate stuff matters so much!

Monthly Overhead Figures x 12 = Annual Overhead

I’ve provided a downloadable overhead worksheet to help you out with this: Overhead Worksheet (PDF)

Billable Hours

“I’m open 8 hours a day, so that’s my billable time.” Wroooooooooong. Your billable time is the time you spend actually working on projects for your customers, that they are paying you to do. In a one man shop like mine that meant about 4-6 hours of my 12 hour day.  The rest of the time I was running around, spec-ing jobs, doing errands, hauling posts and plywood… you get the idea. The best figure I’ve been able to come up with as a suggestion to you is to figure out:

• How many employees you have that actually do project related work
• Whether they are part or full time
• Multiply the part timers by 3 hours and the full timers by 6 hours.  That will give you your daily billable hours.

Now let’s make it annual.  Assume that you are not working for a month of the year due to vacations, holidays, you name it.  Even if you really are working (I know I was), make this assumption anyway so that you can actually take a vacation!  You probably desperately need one. That leaves you with a 48-week work year.  Take the 5 or 6 days you are open each week, multiply that figure by 48, and then multiply the result by your daily billable hours.

Work Weeks x Days You Are Open x Daily Billable Hours = Annual Billable Hours

Now that you have your annual overhead and your annual billable hours, you can do the first eye-opening bit.

This is the scary part.

Take your annual overhead, and divide it by your annual billable hours.  This is the hourly rate you have to charge just to BREAK EVEN.

Annual Overhead ÷ Annual Billable Hours = Break Even Hourly Rate

Wow.  If you’ve never done this before, it’s probably a good time to crack open a beer and stare at a wall in amazement.  Usually this figure is actually pretty close to what you are charging now.

Why?

People have an instinctual understanding of what their costs are.  What we don’t have an instinctual relationship to is profits.  So we pretty much charge what we know we have to, from instinct, but don’t build in any profits for ourselves.  That’s what we’re going to do next.

Profit

Yes, the P word.  There are a couple of approaches to this question, and a couple of ways to figure it.  The first way is as a dollar figure you want to earn.  The second way is as an overall percentage.

I like the first way, because I know that any time I need to make more money I can just up the figure and watch the dollars roll in.  An average shop will have about 16 billable hours in the day, or 3,840 billable hours in the year.  So adding just ONE BUCK to my shop rate will put $3,840 more in my pocket in one year, or $320 in one month.  Got a surprise expense? Raise your rate a buck.  These are hard numbers, folks, not “fuzzy math.”  Your hourly rate is your number one tool in your business arsenal.

Here’s how to do it the first way, as a dollar figure you want to earn: this is easy.  Take the figure you want to earn each week as pure profit, multiply it by 52 (you want to profit every week, even if you’re working only 48 weeks).  That’s your annual profit target.

To do this the second way, as a percentage of profit:

Take the percentage amount you want to see as profit and do the following math (i’ll use 35% as an example):

• Subtract the percentage from 100 (this gives you your margin, or 65 in my example).
• Divide the result by 100 (this gives you your profit factor, or .65 in my example).
• Divide your annual overhead by your profit factor and you will get the annual profit target you are looking for.

“But Mark, if I want 35% of $100,000 overhead, I just use $135,000, right?”  Nope.  The reason is that you’re looking for a percentage of your total billing, not a percentage of your overhead.

$35,000 is 35% of $100,000, sure.  However.. once you add the $35,000 to your overhead, your total billing is $135,000 — and $35,000 is just 25.9% of that figure.  You’d be missing your target.

With the method above, you come out with $100,000 ÷ .65 = $153,846 … and $53,846 is 35% of that total.  If that doesn’t make sense, read it again.. or just follow the steps.  They work.

Now you see why I like the first method better.

Taxes

Shiver.  Yeah, they suck.  There is a way to make sure you pay them ahead of time, though, and not lose your shirt — you can build them into your hourly rate.

First, remember that you only pay taxes on your profits — the government is friendly enough to let you deduct your overhead expenses from your taxes.  Otherwise we’d all be seriously screwed.

Basically, you do the same thing as the percentage method for profit I outlined above, but only to your profit figures.  When you do this, remember federal, state and local taxes — and add ‘em up!  It can be a mighty big number.  I’ll use a figure of 40% as an example, and yes, it really can get that high.

Here’s the math:

• Subtract your tax rate from 100 (100 – 40 = 60, your margin figure)
• Divide the result by 100 (60÷100 = .6, your tax factor)
• Divide your Annual Profit Target by your tax factor to get your Annual Tax Burden.

Annual Profit Target ÷ Tax Factor = Annual Tax Burden

Now For The Fun Part (Drumroll Please)…

Now you’re ready to figure your hourly rate! Do it this way:

Add up your Annual Overhead Figure, your Annual Profit Target, and your Annual Tax Burden.  This figure is commonly referred to in business as your “Nut.”  Make of that what you will.

Divide this figure by your Annual Billable Hours and you will have the hourly rate you must charge to make the money you want to make.

It sure isn’t twenty five dollars an hour, is it?

Your “Nut” ÷ Annual Billable Hours = Required Hourly Rate

Some Tools To Help You Do This

I hope by now you’ve been convinced that your hourly rate is the core of all your business principles, and can’t be chosen lightly.  I’ve attached an overhead worksheet to this document that you can download here, to assist you in doing all of this.

• Overhead Worksheet (PDF)

ProfitWatch

Another way to do this is with our ProfitWatch software, which I’d be remiss if I didn’t mention it here.  Keep in mind it works for any business, not just sign companies. It does all the math for you and provides a way to easily maintain your hourly rate through a wizard-like interface.  While you can do this yourself with this article and the worksheets, ProfitWatch is definitely a faster and easier way.

Order ProfitWatch here if you like.  It’s a whopping $29.

All of this functionality is also built into EstiMate’s Hourly Rate Wizard, which is the heartbeat of how EstiMate keeps you profitable.  If you’re not already using EstiMate, you should be.  Of course, I’m biased.

Update 1-22-10:

RateMate for OS X is now available – it is a port of ProfitWatch to OS X.

RateMate is also available for the iPhone.

Thanks for reading.  Go figure your hourly rate!