Learn how pay rates, cost rates, and billable rates impact profitability.
Pay, cost, and billable rates are important accounting terms. They tell you about the money coming in and going out of your business (“cash flow”). And together, they determine your profits.
Here’s an overview of what they are and how you can manage them.
Learn about cost types and terms
Pay rate is the amount you pay a worker (employee or independent contractor) to do work for a set amount of time. This is also known as a wage.
For hourly workers, the pay rate is their wage per hour. For salaried employees, the pay rate is usually calculated by month or year.
Pay rate is only what you pay your workers. It doesn’t include the additional costs to your business such as benefits, overhead, or employer taxes.
Employee cost rate is the total cost for an employee to do work for your business. This typically includes wages (“pay rate”), benefits, overhead, and taxes.
|Pay rate + overhead + employer taxes + any additional expenses =
employee cost rate
Overhead isn’t a single cost but made up of many different costs. Some costs may be relevant to your business, others may not. Follow the link if you need help calculating your overhead.
The cost rate for products includes the purchase price (from vendors), manufacturing expenses, and shipping costs. These are just a few things that can make up your cost rate for products.
|Purchase costs + additional expenses = product cost rate|
Billable rate is the amount you charge customers for products and services. Essentially, it’s the price. The billable rate determines how much you will make from sales. This is separate from the bills you pay to run your business.
Instead of charging billable rates, some people use progress invoicing to create multiple invoices from a single estimate.
Manage your pay rates, cost rates, and billable rates
So, how does this all add up?
Pay rates and cost rates represent expenses to your business. Billable rates, on the other hand, represent potential income.
|Sales (income) - cost rates (expenses) = profit from a sale or project|
These rates are all manageable. How you manage them (“job costing”) depends on your business plan and customers. There’s no single right way to do it. Keep these in mind as you’re managing your business and projects:
- Make sure you’re paying your workers fair wages that are sustainable for your business.
- Review your products and services as often as possible. Use financial reports to see what's selling well. Adjust your billable rates as needed.
- Make sure you're accounting for your general overhead expenses, not just direct costs for projects or running your business. Otherwise, it may feel you're making more money than you actually are.
- Some costs, like employer taxes, are outside of your control. Make sure you’re planning ahead for these types of costs.