5.   BILLABLE HOURS PRICING

Billable Hours Pricing is a pricing method used, in most cases, by service businesses who charge customers on a per hour basis. Services such as engineers, plumbers, carpenters, accountants, lawyers, hair dressers, fitness instructors, financial analysts, electricians, surveyors, consultants, and maid services, for instance, usually charge on a per hour bases.

The billable hours pricing method attempts to estimate the maximum number of hours, within a year, a service business can generate revenue. The maximum number of billable hours for the year is then divided into the company's yearly forecasted operating expenses. The resulting figure provides an hourly rate that must be cahrged  in order to cover all operating expenses for the year (profit of zero). Below depicts the three steps required in setting a per hour rate.

Step 1   determine your maximum billable hours for the upcoming year.
Step 2   determine your operating expenses for the upcoming year.
Step 3   determine the price you must charge on a per hour basis.

Lets look at an illustration so that users of this approach can understand the principals involved.

Assume, Mike Jones is a plumber and for years has been thinking of setting up his own plumbing company. Also assume that Mike plans to be the only employee of his company. He is currently at the stage of determining the amount he must charge his customers on a per hour basis. Below details the steps Mike would take in order to determine his per hour selling price (rate).

STEP ONE - determine your maximum billable hours for the upcoming year
This step involves estimating the total number of working hours within the year as well and the total number of hours considered non-billable for the year. By subtracting these amounts, you will arrive at the maximum number of hours your company can potentially invoice customers during the year. In essence, you are trying to determine the total number of hours your business can potentially earn revenue.

A:   The Total Number of Business Hours for the Year:
For simplicity, lets say Mike is the only employee in his plumbing business and the business will be open 40 hours each week. Therefore, the total number of hours in which Mike will work during the year is 2,080 hours (40 hours per week multiply by 1 employee multiplied by 52 weeks in a year = 2,080 hours).

B:   Total Number of Non-Billable Hours in the Year
Now Mike must determine the total number of non-billable hours for the year. To do this, he would estimate specific events or tasks requiring "time" and therefore  will reduce the hours in which he can bill customers (generate revenue). Some of the most common items include vacation days, sick days, banking, bookkeeping, time for eating, travel time, down time, and miscellaneous time. Below illustrates items Mike feels would require time away from performing actual work for clients.

Vacation Days:
Mike plans to take 2 weeks each year for vacation. Since the business is open 40 hours per week and he is the only employee, Mike will loose 80 billable hours each year (40 hours per week x 2 weeks = 80 hours).

Sick Days:
Mike estimates three (3) sick days per year. Since he is the only employee, these sick days must be considered non-billable hours. Thus, 24 hours is allotted for sick days (per year) and considered non-billable (3 days at 8 hours each day = 24 hours).

Banking and Accounting Time:
Mike estimates 2 hours each week will be spent on preparing customer invoices, accounting and banking procedures. Therefore, banking and accounting time creates an additional 104 non-billable hours per year. (2 hours per week multiplied by 52 weeks per year = 104 hours).

Time for Meals:
Another time consuming activity is eating. Lets assume Mike estimates 30 minutes each day for eating meals. As a result,  Mike will spend 130 hours eating his meals over the year. ( 2.5 hours per week multiplied by 52 weeks each year equals 130 non-billable hours each year for meals).

Travel Time:
Since Mike is opening a plumbing company, he will be required to travel to the homes of clients in order to perform the necessary plumbing work (this is considered a mobile service). This requires travel time which Mike must calculate into his price. Lets assume that travel time is estimated at 1 hour per day or 8 hours per week. Therefore, 416 hours during the year is estimated for travel time and must be considered non-billable hours (8 hours per week * 52 weeks = 416 hours).

Down Time:
Down time is time in which you are waiting for customers to call or walk into your place of business. Down time is usually underestimated by many entrepreneurs since they feel customers will "flawk" to buy the service in which they offer. Lets assume Mike estimates downtime at 8.5 hours per week. This means, 442 hours per year will be downtime and, therefore, considered hours in which the Mike can not bill his clients. ( 8.5 hours each week x 52 weeks in a year).

Now lets chart the above numbers to determine the maximum number of hours Mike's plumbing company can actually bill its customers.

Total Hours Available Per Year
(40 hours per week x 1 employee x 52 weeks)                   2,080 hours

Less Non-Billable Hours for:
Vacation                                            80 hours
Sick days                                           24 hours
Banking and Accounting                  104 hours
Time for meals                                 130 hours
Travel time                                       416 hours
Downtime                                        442 hours
Total non-billable Hours                                                     1,196 hours

Maximum Billable Hours for the Year                                884 hours

Therefore, the maximum number of hours Mike can be bill to his customers for the upcoming year is 884 hours. In other words, 884 hours is the maximum number of hours in which Mike can generate revenue from his customers. This concludes step one entitled, "determining the maximum number of billable hours for the upcoming year" (884 hours).

STEP TWO - determine the operating expenses for the year
Operating expenses consist of a company's marketing and administrative expenses. For your business, you'll be required to determine your own operating expenses. For our plumbing company example, lets assume Mike estimates his total marketing expenses at $8,000 and estimates his total administrative expenses at $55,000 for the upcoming year. Therefore, the plumbing company estimates operating expenses of $63,000 for the year ($8,000 + $55,000). Note: Cost of Goods Sold will not be used in this example. This concludes step 2 - determining the operating expenses for the upcoming year ($63,000).

STEP THREE - determine the price you charge for your service
Step 1 determined the maximum number of hours in which Mike could bill his customers (884 hours). Step 2 determined Mike's total operating expenses for the upcoming year ($63,000). Step 3 will determine the price Mike must charge his customers in order to cover all his anticipated expenses. To determine his selling price, Mike simply divides Step 1 into Step 2.

     Total expenses for the upcoming year           =        $ 63,000
Maximum number of billable hour for the year               884 hours

                                                                            =       $71.27 per hour

Therefore, Mike must charge $71.27 per hour in order to cover all of the company's expected operating expenses. In other words, if, at the end of the year, Mike billed 884 hours to customers and charged them $71.27 per hour, he would generate $63,000 in revenue. Revenue of $63,000 would cover the expected expenses of $63,000; therefore leaving him with a year end profit of Zero ($0.00).

What price would Mike have to charge his customers in order to make a profit of $10,000? To determine this, Mike would simply add the desired profit to the expected expenses and divide the maximum billable hours into the sum.

Here's how it's calculated;

Forecasted Operating Expenses                $63,000
Desired Year End Profit                              $10,000
Adjusted Amount                                     $73,000

     Adjusted Amount                        =          $73,000
Maximum # billable hours                           884 hours

                                                        =         $82.58 per hour

In summary, Mike must charge customers $71.27 per hour in order to cover his forecasted operating expenses OR charge $82.58 per hour in order to cover the forecasted operating expenses and make a profit of $10,000. If customers are unwilling to pay either hourly rate, he has two options; (1)Increase the number of billable hours or (2)decrease the expected expenses for the year.