Let’s face it, you didn’t start an agency because you’re obsessed with numbers. But whether you like it or not, understanding your business and how to set yourself (and your team!) up for success often starts with and comes down to numbers. As revenue operations expert Steph Hermanson put it at Bandwidth, “If you don’t know your numbers, you don’t know your business.”
We all want more confidence and accuracy when it comes to managing resources, tracking against your budget, and understanding your profitability. This is especially true for agencies, where getting profitable and staying profitable can be a bit more of a challenge. It's all about balancing profit and team resources with (precise!) project cost estimation.
Sounds easy enough, right? But how can you make sure your budget predictions are accurate after it's all said and done? In this post, we’ll break down a tried-and-true formula for calculating billable hourly rates as well as common ways to look at project and retainer-based fees, so you can make sure the next big project or client you sign is a win for all—your client, account team, and your bottom line!
First, calculate annual billable hours
There are a few ways to calculate this, but we’re sharing one of the simplest of them all because, numbers can be hard enough as it is!
Before we look at annual billable hours, let's quickly look at the flip side: non-billable hours. You can’t charge clients for 100% of hours worked, although that would be nice! There are tasks like new business outreach, proposal writing, admin tasks, and many more that suck up precious time. These are what are considered non-billable tasks.
Now, let’s get calculating all those client tasks you should be billing for!
If you take into account an average 40 hour work week and 52 weeks per year, that will give you a total of 2,080 work hours per year. You have to then take into account vacation time, sick days, and holidays. For example, if you account for three weeks of vacation (15, eight hour days), one week of sick days (five, eight hour days) and about 11 US holidays per year, each employee has about 1,832 billable hours per year to bring to the table.
Let's say for instance you bill clients 75% of the time, that leaves you with 1,374 billable hours per year (1,832 * 75%) per employee.
Next, if you divide your target income for a project by your total billable hours per year, this will give you an idea of how much you need to charge in order to cover expenses, and leave enough of a comfortable profit of your own. For instance, if your target income for a project is $100,000 (for a project or retainer—more on this below) and billable hours per year (per employee) are 1,374, the employee’s hourly rate should be about $72/hour ($100,000 / 1,374).
Other factors to consider: Fixed or role-specific hourly rate
It's not uncommon for agencies to have a fixed hourly rate per role. For example, all account managers have an hourly rate of $150, account specialists $100, and account coordinators $75. Other agencies may have a fixed hourly rate per team member, no matter what role or experience level. Let’s also keep in mind that if your full-time team gets paid salary, the hourly rates you calculate are more to reference for project/retainer budgeting purposes versus what you are actually paying staff, which is likely a whole other line item and budget all together.
Next, determine your agency fee structure
Agency fee structure is how much you are charging a client for your services and for deliverables.
As with your billable hourly rate, there are many ways to calculate this, but here’s one approach we like for ease of use because again……numbers!
First, we’ll take a look at the two ways agencies typically charge clients: on a project basis and a retainer basis. Project-based fees
“Projects” entail doing work for a client with a shorter time-line—with a definitive start and end date and where there isn’t an on-going contract involved. But let’s face it, projects can be tricky to price out. Why? Because projects can be less predictable, especially because they often involve a whole lot of work, packed into a short period of time. If you undervalue a project substantially, there usually isn’t a way to make it in a short timeframe. Whereas if you are working on a retainer basis for instance, if you go over hours for the month, perhaps next month the team goes a bit lighter on hours to account for this.
While there are many ways to calculate the cost of a project, one of the most accurate ways (or so we think) to do so is with parameter estimation.
Parameter estimation has you looking at data from past projects to help price out an upcoming project with more accuracy. Here’s how it works:
Keep in mind hourly rate of each employee
Estimate how much time you think each team member will spend on a task. Remember to cross-reference with past projects completed with them involved or someone at the same level. If you use a project management tool like Teamwork, the Project Time Budget utilization tool in particular, will automatically keep all data on file from past projects for you to refer back to.
For each task calculate: Number of billable hours x employee’s hourly rate = Task cost
With this approach, you account for each team member’s billable rate (should they differ).
Optional: Add a contingency to provide a bit of buffer for extra costs that may be incurred. This can be anywhere from 15-25% and can be factored in on a project by project basis.
Other factors to consider: Agency mark-up
It's not uncommon for agencies to add “mark-up” to fees in addition to the above, similar to when you shop at a store and they mark up the original cost they pay for said product, to make a profit. While the mark-up amount itself differs from agency to agency, oftentimes agencies add anywhere from a 15-25% markup.
Odds are you are doing a happy dance when you score a retainer client. This means you are working with a client on a long-term on-going basis, with more flexible deliverables. Instead of a 1-month project for instance, retainers are often up to a year or more and provide you with stable payments. Oftentimes, the deliverables for retainer-based projects are more flexible given you’ll have more time to complete them. The tricky part really is—how do you calculate 12 months of work in advance?
We’d recommend your retainer cost factors in both hours and deliverables. This means that the client agrees on a certain number of deliverables they’d like to see completed at the end of every month and you price this out per team member and their billable rate, similar to a project.
Where this differs from a project-based retainer is when additional deliverables are added that are what we say “out of scope” i.e. not what was agreed upon in your outlined “scope of work (SOW),” or “statement of work.” We would recommend you price those out separately. For instance, if your client decides they would like to enlist your team to help plan a launch party, if your SOW is only for social media management, the event would be priced out as a separate project. This helps your team focus on the deliverables you are contractually obligated to, while keeping your team’s capacity in mind.
Other factors to consider: Performance-based work
You can also charge clients based on performance i.e. when you meet particular milestones or deliverables. When your team hits X number of impressions on a campaign within a certain period of time, then you get paid. For obvious reasons, this can be risky, especially with work such as publicity where there is never any guarantee of coverage for countless hours spent on work.
Final thoughts: Build budgets from the bottom up
When it comes down to the dollar amount to charge for a project or retainer, always remember to look back at other work you have completed as a guideline (don’t try to reinvent the wheel!). How much time did each team member spend? Did you under or overestimate this previously? As well, keep each team member’s billable hourly rate in mind too.
No matter what, know your bottom line, and know where you can and cannot compromise when it comes to what you charge clients. A good way of thinking when building out cost estimates, is to always start with the minimum you can offer and build from this based on the clients needs and budget range in mind. At the end of the day, if you undervalue a project or retainer, it's your bottom line and your team’s bandwidth that suffers. Last but not least, if you’re not 100% sure how much time your team is spending on tasks and projects, the right software will. See how Teamwork can help