There’s a lot of confusion in the agency space about what should or shouldn’t be factored in when calculating your billable employee cost-per-hour.

Should I include overhead? Should it be based on their gross capacity or just their billable capacity? What about employees that are part-admin and part-billable? What about benefits and insurance? Production software?

What should and shouldn’t be included?

There’s a lot of mud in the water, and you’ve probably read a lot of conflicting information on the subject.

That’s why I’m writing this guide to give you a clear answer. I want to help you understand how to calculate this important metric in the different contexts you might encounter in your agency.

Why do so many people calculate employee billable cost-per-hour the wrong way?

In my experience, most of the confusion around what to include and what not to include here comes down to not being clear on how this cost-per-hour number is going to be used. (And what questions it’s going to help answer.)

I see this most often when questions about overhead and billable capacity come into the fold. This usually happens when someone is trying to work backward from project-costing to net-profitability.

I could go on a lengthy rant about why I don’t think trying to calculate net-margin on projects and clients is a worthwhile pursuit. (And why it’s actually more useful to understand gross margin on projects or average billable rates). But that’s a whole other post on its own.

The bottom line is that if we’re looking at the project/client level – we generally want to focus on Gross Margin first. This is because it helps us understand how efficient we are at earning revenue in our agency or service business.

Afterward, we can use the information about Gross Margin to build our insights into Net Profit on a broader level for our agency.

The reason we want to focus on Gross Margin or Average Billable Rates is that it’s the foundation for the profitability of the entire agency. If we can’t consistently protect gross margin on projects and earn our revenue in an efficient way, getting healthy net profit will be extremely difficult (or impossible)

So for the context of this post, I’m going to discuss how to Calculate Billable Employee Cost Per Hour for the purpose of calculating Gross Margin on clients & projects or evaluating the hard cost of doing internal projects.

The Formula

In this context, Cost-Per-Hour is expressed by the following formula:

Fully Loaded Cost / Gross Capacity

This means we need to identify two things in order to Calculate Billable Employee Cost Per Hour:

  1. Employee Salary + Benefits (Fully Loaded Cost)
  2. Gross Capacity

Some notes before we begin:

  • In the context of this post, Billable Employees refers to team members whose primary responsibility is doing work for paying clients.

  • If you have team members who are Partially-Billable, you should allocate a portion of their salary based on the % of their time spent on billable work and adjust their capacity (in hours) accordingly.

  • We define Billable Work as any time spent doing anything for clients that pay you money. (Regardless of how you charge that client, or whether or not that time brings in any additional revenue.)

  • We’re not going to factor in overhead in these hourly costs. Since the primary objective of this exercise is to assess the Gross Profit margin at the project level.

The Steps to Calculating Employee Cost-Per-Hour in Your Agency

I – Calculate the Fully Loaded Cost of Your Employees

The first step in getting to an accurate number is looking at the loaded cost of your billable employees.

This means tallying up the following things:
  • Salary
  • Benefits
  • Payroll Taxes
  • Insurance
  • Training & Development
  • Perks, Equipment & Software Licenses
  • Any other expenses that would otherwise not exist if these people did not work for you.

For a more comprehensive list, check out this blog article by MIT

As a rule of thumb, an additional “burden” costs will generally be about 15-30% of a person’s salary depending on your perks and benefits packages.

As an example:

Salary60,000 
Payroll Taxes6,00010%
Benefits10,00016.7%
Insurance9001.5%
Total Burden16,90028.2%
Total Cost76,900 

You’ll want to build out this kind of a graph for each employee, or at least figure out what the blended average “burden” % is for your company. Then apply it across your team to hone in on a more accurate loaded cost for your billable team.

II – Find Yearly Available Hours per Employee

The next step is to figure out what each employee’s capacity is, so you can figure out their cost per hour.

This is fairly straightforward but is often done incorrectly. So we’re going to break it down.

A – Calculate Gross Capacity

The first step is to figure out each employee’s Gross Capacity. This is the total number of hours you’re essentially purchasing in bulk via your employment agreement.

Generally, this is 40 hours per week X 52 weeks in a year which comes out to around 2080 hours per year.

Generally, we think about this in terms of how many hours per week we’re paying them for in a given period of time. We want to make sure to include any “paid time off”. This includes sick days or vacation days that we’re compensating them for, even if they’re not working for us during that time.

III – Calculate Employee Cost-Per-Hour

Now to calculate the hourly cost of each of your team members, you’ll need to bring these pieces together.

In this context, Cost-Per-Hour is expressed by the following formula:

Fully Loaded Cost / Gross Capacity

You’ll want to divide your Loaded Annual Cost by your Capacity to get to your Cost Per Hour for each employee.

Example:

Salary$60,000
Benefits$16,900
Total Cost$76,900
Capacity2080
Cost-Per-Hour$36.54

That’s it! You now have an accurate calculation for Employee Cost-Per-Hour. You can use it to figure out your gross margin on projects, as well as calculate the cost of internal project investments in your agency!

If you’re looking for an easy way to calculate this for your entire team, as well as lots of other awesome tools for improving your agency’s profitability; Check out the Agency Model Generator Template that’s included in our Free Agency Profitability Toolkit:


Have questions? Leave us a comment, we’re here to help.