Business advice

How to calculate a charge-out rate

By 24th February 2021 No Comments
How to calculate a charge-out rate - rory finegan

Are you having trouble calculating the value of your services? The good news is that you’re not alone. Charge-out rates are used in all sorts of businesses, from service providers to product manufacturers. Calculating how much you should charge for the use of your resources can, on the surface, seem like a simple sum of division (the employee’s salary divided down to their labour hourly rate). In reality, this is far from the case.

Many clients have come to me because they are having problems ascertaining what is a fair charge-out rate for their services. It’s very easy to get bogged down in the books with something like this, but over the years I have found that it is rarely worth the drudgery. Instead, I’ve come to the conclusion that there is a certain handy rule of thumb which any business can employ to solve this problem.

Using the rule of threes for a fair charge-out rate

Many professional service firms use a model that says: If I employ someone one at a salary of X, then I need them to produce work that is three times that in fee income. The reason it’s three times is because one-third of the fee income goes directly towards covering the salary, another third goes to covering the other costs associated with the firm (such as rent, IT, travel, etc.), and the final third is for generating a profit for the owner or shareholders.

This rule of threes has stood the test of time in business. It’s a rough estimate, but it is very helpful when trying to get your head around something such as charge-out rates. It also has the added benefit of being easy to apply. In your operations systems, you’ll probably find that you’re asked for how much an hour for a particular service costs and then this is followed up by how much it costs for you to supply this service. This is why the rule of threes is beneficial – it takes into account your overheads.

Calculate the average charge-out rate for your company

This model is not restricted to a per-person calculation. You can also assess a charge-out rate by class of service. For example, if you are a graphic design company you might benefit from having a standard charge-out rate no matter who is doing the work. Everyone may be on different salaries, but if you have a charge-out rate that will average out at three times the total cost of salaries, you still cover your costs and make a fair profit.  

This approach is all about taking advantage of the simplicity of broader assumptions rather than micromanaging your finances. However, you can only know it is OK to do this when you have the experience of working with many businesses’ finances under your belt, which I happen to have! It’s why I can confidently say that the rule of threes is an easy way to price your company’s charge-out rate so you can make a decent profit and cover your costs.