Is-Your-Billable Rate-Profitable

Your billable rate needs to meet two criteria. First, clients have to be willing to pay your billable rate. Second, your creative agency needs to be able to generate a profit at that rate. This is the 2nd article on setting your billable rate(s). In the first article, we discussed methods for setting a billable rate that will maximize demand and revenue. Now, we will analyze what it takes for your creative agency to generate a profit at that billable rate.

The majority of expenses at a creative agency are fixed expenses, such as salaries, rent, and software subscriptions. The goal of this article is to figure out how many billable hours it takes to cover these fixed expenses. Once these fixed expenses are covered, the majority of additional revenue is profit.

To start, you need to find your cost for being open for business. You need three numbers: salary costs, overhead costs, and expected profits.

  • Salary Costs. You need to include salaries for everyone involved in your business — administration, account management, sales, and creative. Make sure to include payroll taxes, and planned bonuses. If you are planning on hiring employees include hiring costs — e.g. setup and training costs. If you are planning on terminating employees include any severance, or paid vacation days if applicable. Read: The Financial Benefits of Unlimited Vacation.
  • Overhead Costs. These are costs that can not be easily tied to a business unit or work. However they are part of your operating expenses. Beyond salary expense, you need to include all ongoing operating expenses. The key is ongoing.  You have to pay these costs to stay in business. They are not incurred only when working on projects, and are not passed through to clients. Examples of overhead costs include, rent, utilities, insurance, software subscriptions, hosting, fees, and taxes. Don’t forget about annual tax preparation, and small taxes and fees such as property tax. Also, I like to include a monthly budget for accounting and legal services.
  • Expected Profit. Your longterm success — even survival — depends on your creative agency’s ability to generate a profit. This is why you need to include profits when calculating how much it costs to be open for business. You will need to reinvest in your business and yourself. Caution: just don’t get greedy. Set your billable rate so that you generate a 10% profit margin — AIGA’s recommendation. This establishes a floor; you can always go beyond that through effective management — 15 or 20% profit margin would be great!

Don’t include any project specific costs. Examples are freelancers, and project materials. These costs are variable. They are only incurred when you do project work. They are required to do work, but not to stay in business.

It can be useful to create a 12-month forecast. This allows you to see how expenses change from month-to-month producing a range of low, average, and high costs. This allows you to “stress test” how much it costs to stay in business. For example, this allows you to take into consideration annual fees, and quarterly expenses.

Next, we need to calculate the minimum billable hours required stay in business.

Minimum Billable Hours = (Salaries + Overhead Costs) + ((Salaires + Overhead Costs)*Profit%) / Billable Rate

*This assumes that all direct project expenses are passed through to the client.

This gives you the minimum billable hours you and your team have to work. I recommend calculating this for each month of the year — on your month-by-month budget.

Finally, you need to calculate your minimum billable utilization rate. Billable utilization rate is the percent of total available time that employees spend working  on billable projects. Finding your billable utilization rate provides two benefits:

  • Provides flexibility. You don’t have to recalculate each time an employee is added or subtracted. Each employee adds costs, but also billable hours. The only time you need to recalculate your minimum billable utilization rate is if someones salary varies significantly from the rest of your team, or your overhead costs per employee increase dramatically.
  • Most importantly, billable utilization rate allows you to come to other creative agencies. You can check to make sure you ratio of costs per billable hour, and billable rate(s) are inline with your peers.

According to AIGA the average billable utilization rate for creative agencies in the United States is 42%, and their recommended billable utilization rate is 65%. I recommend that your billable rate should be high enough that you are able to meet your fixed costs at 42% billable utilization. Make sure you can generate a profit by being average, then you will be able reap the rewards of being extraordinary — instead of have to be extraordinary just to pay your bills.

You can reduce your minimum billable utilization, by adjusting your billable rate up, or your costs down. Likely you will have the most control over your costs. It is uncomfortable to cut costs, but it is better than risking and losing revenue.

In conclusion, most creative agencies are started by people that want to focus on doing work they love. Likely you don’t want to spend all of your time just trying to breakeven. The goal of this article is to help you manage your billable rate and costs so that you can generate a profit without having to worry about running the business.