I’ll start this article by first admitting that for years I had no idea whether or not we were making a profit on many of our projects, it’s only when we’ve sat down to re-organise parts of the business that we’ve started to look at profit margins.
What is profit?
Sorry, I don’t mean to teach you how to suck eggs but I feel it’s important to cover this. Profit is the amount of money you have left over after you’ve paid all of your bills. In terms of an individual project, profit is the amount of money you have left once you’ve received payment for the work and paid any expenses that have occurred for the project. Expenses include your time, other peoples time, and the cost of doing business (phone, rent etc)
Why do we need profit?
Profit it important, very important, without profit you would usually have no money to re-invest in the business. In our case, profit from one year helps us to invest in marketing/tools/software for the following year in the hope that the investment will help us increase profit in the year. There are cases where profit from busy periods of the year helps your business to survive the not so busy months too.
Where to start?
I’m going to assume (maybe wrongly) that you’re a freelancer, so the first place to start is to work out how much you’d like to (realistically) be paid each year. Let’s say you’ve chosen £20,000 a year. From here we need to work out how much your business needs to turnover each year to cover it’s bills and have at least £20,000 remaining to pay yourself.
Work out for a 12 month period what expenses you expect to pay, include things such as rent, phone, internet, software, national insurance, and tax. It’s a good idea to look at your bank statements, what are you paying for each month? Add them all up. For the sake of this example we’re going to assume the following expenses;
Phone (home & mobile): £300
National Insurance: £150
Tax: £2,100 (£20,000 – £9,440/ 100 * 20)
Your Pay: £20,000
Total Expenditure: £26,950
The figure of £9,440 is roughly your personal tax allowance, it’s how much you are allowed to earn each year before you need to pay tax. The figure of 20 is to help us calculate tax of roughly 20%, it may not be totally accurate but it’s a good place to start, your account will be able to confirm exact figures.
Calculating your hourly rate
Using the figure we’ve come up with above, we can work out what your hourly rate needs to be in order to reach that figure each year. There are 52 weeks in a year, but you’d probably like 4 weeks holiday, so 48 x 37.5 (working hours in a week) = 1800 working hours a year.
If we divide your total expenditure by the number of hours in the year (26,950 / 1800) we come up with an hourly rate of around £15.00, that’s the amount you need to charge per hour in order to turnover £26,950. To some people £15 an hour sounds like a hell of a lot of money! But is it? We’re making an assumption that you’re going to be busy every hour for a full year, but in reality that’s never really the case, what about quiet periods, what about business admin that you don’t get paid for? Now that £15 an hour doesn’t look so good does it?
Let’s try again. I read somewhere that realistically if you’re running a business that you’ll only charge for roughly 5.5 hours per day after you’ve managed the business, answered phone calls and replied to an endless number of emails. Working on that basis 5.5 * 5 = 27.5 working hours a week, and only 1320 working hours a year, so our hourly rate is now around £20.50 ( £25,950 / 1320).
£20.50 an hour, damn that’s a lot of money, isn’t it? Sadly, we’re not finished. What happens when you have an unexpected business expense, or you’d like to spend £2,000 on a new website? Where does the money come from? This is where profit is important.
Now for the profit
So far our calculations have not included any profit, and as a result your business has no money to ‘play’ with. Let’s say for example that you would like to make 30% profit, what does this mean?
Essentially you will add 30% to all of your costs, so you’ll have money left over from each project. In practice, you want to be making a profit on each hour you spend on a project, and also making a profit on every expense relating to your business/the project. If you have to outsource work to another freelance and it costs £100, you want to be making a profit on that too. Let’s go back to our expense figures above and let’s say that you’re going to outsource £2,000 of work to someone else during the year, so our expenses now total £28,950, we’d like to make a profit of 30% and to work this out we use this simple formula;
(Total expenses / 100) * desired profit% = Profit
using our figures from above;
(£28,950 / 100) * 30 = £8,685
This means that a profit margin of 30% will leave you with £8,685 per year to re-invest in your business, this could be used to buy new equipment, invest in marketing or be used to see you through the quiet periods.
More calculations I’m afraid. Now we know how much profit you’d like to achieve for the year, we need to work out how much revenue you need to turnover and re-calculate your hourly rate, so we add your expenses and profit together… £28,950 + £8,685 = £37,635. That’s right, you need to turnover £37,635 per year in order to pay your bills, get paid £20,000 and have £8,685 profit left over. To achieve this figure your hourly rate is now £28.51 (£37,635 / 1320).
We’ve done the above with our business and that’s how we’ve come up with the hourly rate we charge our clients. What we’ve started to do is also look at each individual project, look at how much we’re charging the client, how much time we spent on the project and how much it cost our business, and from that we can work out how much profit we’ve made on a project, and if there’s no profit or it’s below our target then we can make adjustments to our pricing our the way which we estimate project costs in order that it doesn’t happen again.
I hope this article has been helpful, it’s purely based on my experience and the way in which we’ve worked things out in our business, it may not be factually correct, but I do hope you can apply a similar logic to your own business and help make (or keep) your business profitable.