Overhead Costs: Calculating Overhead Costs per Each Billable Hour
If you aren’t currently including overhead costs in your billable hours, you’re losing money. Every business, no matter the size, has some type of overhead and you need to include this in your prices. It’s essential that you calculate the cost correctly or you could be paying out of pocket for those clients.
This is one of the most overlooked costs for new businesses and it can make or break your company. Imagine that you make $500 profit your first month, but then have to pay out $400 in overhead costs. You immediately reduce your profit to just $100. Even if you’re making a lot more than that, you still stand to lose. Keeping track of your expenses is an essential part of keeping your business afloat. You need to work them into your billable hours.
What Are Overhead Costs?
Any expenses that do not relate directly to your product or service, are considered overhead. If you make custom shirts, for example, the cost of the shirts and the ink is not overhead. Anything that is directly related to the product you sell is considered part of the product cost.
Most people are aware that things like rent and electricity count as overhead costs. What if your business doesn’t currently rent a space? What would your costs be and how would you figure them out? Let’s first look at what is considered overhead.
There are two types of overhead costs, fixed and variable. Fixed expenses are amounts you pay every month, without fail. These could include things like rent, mortgage, membership costs, etc. They don’t change and do not vary depending on your income. Variable expenses are the costs that change each month. These are usually dependent on your business. For example, you might buy paper one month and not the next. You might spend more in advertising one month, then reduce spend the next month.
Not sure what your costs are? It’s a good idea to sit down and list out everything you spend each month on your business. Ideally, you’ll have receipts saved for tax purposes to make this process simpler.
Take a good look at the space you are using for your business. If you pay rent, then that is part of your overhead. However, other fixed expenses might include:
Salaries for non-product specific employees (bookkeepers, babysitters, etc.)
Anything that you’re paying out each month at the same amount can be listed under this section.
Your variable expenses can be tougher to track, but may be even more important to keep on top of. Since you can’t accurately predict how much you’re going to spend each month on variable expenses, you can average it out. Keep in mind that this works best to set your billable hours, too. You aren’t going to change clients differently each month as your costs change.
Other examples of variable expenses include:
Your business may have different expenses than another. Or you may have virtually no expenses at all. Either way, it’s important to know just how much it costs to keep your business running each month.
Wear and Tear
When you’re figuring out overhead costs, don’t forget to factor in the wear and tear on your equipment. Look at everything you use in your business, from the computer and printer to your phone and vehicle. Even if you don’t use your car 100% for business purposes, everything you do with it for business will affect its longevity.
How to Calculate Overhead Costs
Fixed expenses are nice and easy to figure out, since they don’t change. Where it gets difficult is if you are sharing a space or working from home. Your office space still counts as overhead, even if it is a part of your home. In this case, divide the rent or mortgage payment by the number of rooms in your home and use that number for your office. If you don’t use the home office all the time, you can reduce the cost by the percentage it is used for other things.
For variable costs, total up the amount spent in the past 12 months to get a good idea of how much is being spent. Then divide by 12 to get an average number that you can use per month. Do this with all your variable expenses.
To figure out your wear and tear costs, consider how long the machine is expected to last. Then divide the overall cost of maintenance and repairs by the number of hours it will last. As an example, if you use a laptop for your business, it will likely need to be replaced within three to five years. The battery will need to be replaced in roughly 18 months. You would need to take the cost of the battery and divide it by the number of hours you use it in three years. Consider that you’ll also need to replace the entire computer after that time. The replacement cost will also need to be included.
If your total cost comes out to $300 in 3 years, working an average of 1,500 hours a year, you would divide $300 by 4,500 hours. The total cost per hour for using your laptop would end up being roughly seven cents. You would need to do this for all the equipment in your office to come up with a general wear and tear cost.
Take the time to figure out and calculate your overhead costs so you can ensure that everything is covered when you set your hourly price.
Setting Your Billable Hour Price
Now that you have all the necessary information for your overhead costs, you can set your price per billable hour. Since this type of work usually means you are working more some months and less others, you may not be able to calculate the exact amount in overhead per hour. The simplest way to handle this is to look at your average billable hours.
If you have an average of 100 billable hours in a month and your overhead is roughly $400 a month, you are looking at adding on $4 per billable hour. Take your regular rate and add the $5 to it. So, if you normally charge $25 an hour, your price would now be $29 an hour to ensure that your overhead is covered.
Using this method could result in a little extra money coming in some months, which you don’t necessarily need for your overhead costs. However, since you used an average cost, it will all work out. It’s a good idea to continue tracking expenses and to re-evaluate things each year. After all, prices rise and fall and you could end up paying more next year than you did last year. Being a business owner means adapting to the circumstances and making them work for you.
A smart business is one that covers all its bases. By calculating overhead costs and incorporating them into your billable hours, you ensure that you will never fall short on profit. It may be a common mistake, but it doesn’t have to be one that you make.