Increase your profits and achieve consistent business growth by calculating your fee-earners cost rates to cover overheads
In order to deliver profitable projects that help grow your practice you first need to know your fee-earners cost rates to make sure every hour they spend delivery work driving profit.
What are cost rates and why are they important?
Cost rates are simply the individual costs of an employee to you as a business.
It is important to calculate your cost rates accurately. As an architecture practice, you are trying to sell a service. You employ people to deliver this service but they only have so many hours available in any working week, so you’re actually selling man-hours to your client. You need to know how to price those hours so you’re making a profit on every project you deliver.
Even if you don’t bill your clients per hour, you still need to know how much those man-hours are costing your business so you can deliver an overall quote fee that makes sure you’re not making a loss on the project from the very start. If you know the accurate cost of performing the work you can work out the true profit of your projects.
So how do you calculate cost rates?
There are three steps you need to follow:
- Set productivity/utilisation percentages
- Calculate overhead percentage
- Calculate cost rates
We’ll take you through an example calculation for a Part II Architect.
Set Productivity Targets
First, you need to make a list of individuals at your practice with each of their salary rates and assign a productivity/utilisation target for each individual in your practice. A productivity/utilisation percentage is the amount of time they have available within a year to spend on delivering billable projects.
For example, a Part II Architect on £28,000 would typically spend 80% of their time on billable projects throughout the year, the other 20% accounting for annual leave, sickness, training days, etc. – anything that a typical project worker does that isn’t billable.
Now we multiply their productivity percentage by their annual salary to get the total cost of that employee’s salary that we can recover on projects.
Using the example above, you could expect a Part II Architect to recover £22,400 of their salary in billable project time – £28,000 x 80% = £22,400. The difference of £5,600 is the cost of their non-billable time, which is an overhead to the business.
Once we work this out for all individuals in the practice we arrive at a Total Salary Recoverable figure.
Next, we need to take the combined non-billable time overhead for all individuals and add it to our other overheads (rent, bills, software costs, pensions, national insurance, etc.) to arrive at a Total Overheads figure.
Calculate Overhead Percentage
Next, you need to calculate your overhead percentage figure. To do this, divide your Total Overhead figure by the Total Salary Recoverable figure. Your answer will be relative to the scale of your practice and can be anything from 50% to 300%.
For example, let’s say our Total Overheads figure is £525,000 and your Total Recoverable Salary figure is £480,000, your Overhead Percentage would be:
£520,000 / £470,000 = 110%
Now we have our Overhead Percentage we can calculate your cost rates for each individual in your practice.
Calculate Cost Rates
We take each individual's salary (i.e. £28,000) and divide it by the number of hours they work per year (e.g. 1950 hours) to get an hourly salary cost for that individual (£14.35).
Next, we multiply this hourly salary cost by the Overhead Percentage (110%) we calculated in the last step to get an overhead figure for this person (£15.79).
Finally, we add the hourly salary cost figure and the overhead figure to arrive at a Total Cost for the individual (£14.35 + £15.79 = £30.14).
Do the same thing for each individual in your organisation and you’ll have an accurate man-hour cost for every individual in your business.
This will help you understand what hourly rate you should charge for each member of your fee-earners.
To make sure your calculations are correct, take the cost rate of each individual and multiply that by the total hours spent on projects and you’ll end up with an overall figure to recover the cost of the business.
The total should equal the total cost of running the practice. If it doesn’t then you’ve done the calculation incorrectly.
Where can you go wrong?
There are a few reasons your calculations may still go wrong:
- Productivity targets are actually 10-15% less than what's been accounted for. The impact of this is that cost rates are too low.
- You forget to recalculate after staff receives a salary increase.
- Fluctuations in staff size mean you either have more people to recover your overheads on, or a reduction in staff means your cost rates will go up.
You need to be regularly calculating your cost rates to make sure you’re recovering overheads whilst still being competitive. Getting this into your diary as a biannual process provides the perfect opportunity to check your staff numbers and salaries, further ensuring your rates are consistently accurate.
If you want to learn more about how to make sure all your projects are profitable in order to grow and scale your practice, don’t worry we’ve got you covered!
Download our free guide and we’ll show you how:
- The CMap PETAL Framework for ensuring profitability by eradicating underquoting and over-delivering
- How to increase profitability in your practice so you can afford more creative freedom
- How to make quick and easy changes to your processes so that you can identify a costly project early
- Ways in which you can make sure your Practice is working efficiently to achieve consistent growth