How to calculate an hourly rate

Add up what the business needs to cover in a year, add the profit you are aiming for, and divide the total by the hours you expect to bill in that year. The answer is the hourly figure that would cover your costs and meet your profit target if every one of those hours was billed and paid for.

business.gov.au's pricing guidance describes this approach for businesses that do work for customers rather than sell physical products, and says to convert the business's costs into an hourly figure, wages and leave entitlements among them. The figure you reach is a starting point. You still test it against the market and the value of the work before you decide what to charge.

Use the latest full year from your profit and loss statement as a base, then adjust for anything you know will change. Include:

• Your own pay. For a sole trader, what you take out is usually drawings rather than an expense in the books, but the rate still has to cover it.
• Staff costs. business.gov.au suggests counting the full cost of an employee, with pay, leave and other entitlements, not just the hourly wage.
• Overheads, such as rent, insurance, vehicles, phone, software and accounting fees.
• Direct costs you don't charge separately, such as small consumables used on every job.

Leave out materials and subcontractors you pass on to customers as separate items on the invoice. They are priced on their own, so building them into the rate as well would charge for them twice.

The profit target is what you want left once all of those costs, your own pay included, are covered. It funds new equipment, repays debt and carries the business through quiet months. business.gov.au's cash flow tips suggest planning ahead so known quiet periods are covered, and its pricing guide says making a profit is the most common pricing goal.

The size of the target is a business decision. Write it down as an amount for the year so it sits in the calculation alongside the costs.

This step needs the most care. Start from the weeks in the year, take out the weeks you won't be working, then take out the time each week that no customer pays for directly.

Your own figures will differ. The most reliable way to find them is to record your time for a few typical weeks, including the time that never reaches an invoice. Billable hours have to be above zero, and every hour you overestimate here lowers the rate the method gives.

1. Total the year's costs, including your own pay.
2. Add the profit target.
3. Divide the total by the year's billable hours.
4. Compare the result with what customers pay for similar work, and with the value the work gives them.
5. Decide the rate, and record how you reached it so you can update it later.

For help settling on a rate, business.gov.au suggests asking your accountant or a business adviser.

Work out billable hours for each person, because a manager who spends much of the week quoting bills far fewer hours than a technician on the tools. Each person's employment cost divided by their own billable hours gives a direct cost per hour for that role. Spread the overheads across everyone's billable hours combined, then add the profit target in the same way, so each role's rate carries its share.

business.gov.au says a customer has 30 days from receiving the first bill or invoice for a service to request an itemised bill, and it has to be provided at no charge within 7 days of the request. The bill must explain how the price was calculated, list the labour hours and the hourly rate where those apply, and list any materials with what was charged for each.

Timesheets that record who worked on each job, for how long and on what make that easy to produce, and they show whether billable hours are tracking to plan.

Each month, compare the hours actually billed with the billable hours the rate assumed. If billed hours fall short, the rate won't bring in the year's costs and profit target, however carefully it was worked out. business.gov.au's advice is to revisit prices at least yearly, and any time your costs or the market change.