Accounting for an hourly Rate

There are two things to know that are often helful:

How much to charge for your work. This is sometimes a problem for consultants, home businesses, and craftspeople.
How this may affect a break-even analysis.

Determining An Hourly Rate

Basing an hourly rate on the competition, whatever you think the the traffic will bear, or simply an intuitive feeling may be satisfactory, but at the least you should have an idea of what a lower limit might be.

You need to determine four quantities:

Essential costs (E), the minimum costs needed to survive.
Advancement costs (A), costs to advance one's position in or quality of life. This could be substantial for a younger person.
The proportion of time spent on "production" (p). For a consultant it is the proportion of time spent consulting, for a furniture maker, it is the proportion of time spent making furniture. The remainder of the time goes toward administration, marketing, bookeeping, etc. A good starting point is to assume p to be one-half of the total time at work; except that if travel is part of the job, it could be much lower.
The total amount of time at work for the period in question (T) (year, month, etc)

The minimum hourly rate to charge is then:

r = (E + A) / (p * T)

For example, assume essential costs E during a month to be:

Food	800
Rent	900
Utilities	80
Telephone	80
Clothes	60
Gas	40
Misc Repairs	100
Total	2060

Possible advancement costs A:

Home ownership fund	1000
Vacation fund	150
College fund	1000
Automobile fund	200
Entertainment	100
Total	2450

Assuming an average work month to contain 166 hours, of which half goes into production, the minimum for an hourly rate to meet these expenses is:

r = (2060 + 2450) / (0.5 * 166) = $54.34 / hour.

For a consultant requiring travel on the job, the proportion spent in actual consulting may be much less and an hourly rate perhaps two to five times this amount may be necessary.

Time And A Break-Even Analysis

Where a manufactured product or a service is at issue, it is possible to integrate the formula for an hourly rate with a break-even analysis. The result is a relationship between the maximum time allowed to do a job and the price, in terms of all of the costs, both personal and job-related. This requires four of the quantities defined above plus four more which are part of a break-even analysis. All together they are:

Proportion of time for productive work, p
Total time at work during the period in question, T
The price for a product or a fixed price for consulting, P
The variable cost, exclusive of the owner's salary, V
The total fixed costs of the business, exclusive of the owner's salary, F
A profit goal for reinvestment into the business, I
Personal essential costs, E
Personal advancement costs, A

The relationship looks like this:

t(hours) <= p * T * (P - V) / (F + I + E + A)

P >= [t(hours) * (F + I + E + A) / (p * T)] + V

Here, t represents the time in hours for accomplishing the task.

Let's try an example, as usual entirely fabricated for the purpose.

Suppose a person who has the essential and advancement costs described above hopes to start a small business manufacturing a single product. For the costs of the business, we can reuse the example of a reseller in the break-even analysis, except that what was shown in that example as the cost of the product is now the cost of the parts and materials needed to produce it. So the variable costs are still $2.80. The annual fixed costs were $71,225 in that example, but we need to exclude the salary, since the personal costs already take it into account. So the annual fixed costs are $21,225, which means monthly fixed costs of 1/12 of that, or about $1770. In addtion, we will assume a planned profit goal of $1000 per month for expansion, and that half of the time at work is for actual production.

Let's assume that the processing time is 15 minutes, or a quarter of an hour. We then calculate a minimum price to charge of

P >= [0.25 * (1770 + 1000 + 2060 + 2450) / (0.5 * 166)] + 2.80

P >= $24.73

The price may seem high, considering that it can be made in 15 minutes from parts and materials costing $2.80, but whether it actually is depends, of course, on the workmanship and the competition. Also, it might be possible to put off the personal advancement costs until expansion of the business from reinvesting the profits permits hiring an employee at a lower hourly rate than the owner. In that situation, the price drops to

P >= $17.35

A further reduction in price may be possible by addressing the fixed costs of the business. Another possibility is to use more expensive parts and materials, which would not affect the price substantially, in order to command a higher price. Perhaps one cannot expect to make a good living manufacturing a single product from cheap raw goods. At the very least, the owner can see the effect of all the parameters and is in the best possible situation to determine the potential of the business.