Calculating Budgeted Hourly Rates

As managers, each of us finds ourself struggling at some point to identify why we aren’t making enough money — or how we can make more. In this article, I’m going to attempt to help you understand how to identify cost groups from which you can calculate project cost estimates to compare with market rates. This process will help you see where improvements might be made to control costs better.

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When your in-plant estimates projects, it’s easy to identify how much material such as paper and ink cost; but how do you calculate those costs that cannot be easily identified?

Most Print MIS (Management Information Systems) programs will walk you through entry of cost components from which it will calculate compiled costs for you. If you do not have such a program available to you, you may need to make these calculations yourself.

When we calculate estimates, we must identify a rate per hour for certain equipment or operations. These are called “Budgeted Hourly Rates” (BHRs). But how are these rates identified?

Here are some general steps to help you begin. First, understand this exercise is a mix of identifying exact costs where you can, making somewhat scientific assumptions, and then averaging the result out across the available hours you expect to produce sellable projects. The process is basically made up of calculations of all costs the company incurs for a year, then allocating those costs across a set of cost centers or groups, and then distilling them down to an hourly cost.

Break Your Organization Down

First, identify all steps of your process and break these into “cost centers.” A cost center can be a particular piece of equipment, a general department, or a sub-group of equipment within a department.

Also identify areas that represent support for production but cannot be allocated to a particular cost center. You may choose to group all overhead costs into one overhead group, or you may choose to separate the factory overhead costs (such as estimating, production planning, and customer service) from general overhead (such as sales department, HR, accounting, and executive). Ideally, how you separate these overhead costs should follow how you monitor financial reports on a periodic basis.

If you were building an Excel spreadsheet, the cost centers and overhead groups might be columns in the spreadsheet and each of the following “chunks” of information would be rows.

List Costs Your Business Incurs

Identify the total investment in each cost center. If you were starting out with all new equipment, these costs would be things such as the price you paid to purchase the equipment and any finance charges you paid; the costs to install the equipment and any peripherals needed; and the time required to train your employees to operate the equipment. In most cases, you won’t be starting from scratch, so use the current value or replacement value of the equipment. Calculate this for each cost center.

Calculate the years of useful life of the equipment in each cost center. This is subjective on your part: how soon do you expect to need to replace the equipment?

Dividing the investment cost by the years of useful life gives you a depreciation amount. This is different than depreciation in taxes; this number represents the amount of the investment you hope to recoup from selling projects over a year.

How Many Hours Can You Sell?

You will need to know how many possible productive hours each cost center can produce work in a year.

Calculate the number of hours each cost center can work each year assuming every hour is sellable — no down time, no waiting on another department, etc. In the model we use in a class I teach, we include all straight-time hours (not assuming any overtime), and we do not include holidays or vacations. While you may run equipment during one person’s vacation, collectively the vacation time can affect the possible productive hours available.

Next, note the actual productivity as a percentage for each cost center. As a rule, 85% is a good target, but there are many considerations that affect this. For instance, you may decide to count one piece of equipment as multiple cost centers due to the value perceived. As an example, if you have a four-color press that converts to two-color perfecting, the press can only be run as one of those two at a time. So perhaps it runs as a four-color 60% of the time and as a two-color 20% of the time with known down time being 20%. Or if you have a digital press that is sold at one rate for black only and another rate for full color, you might use this one press as two cost centers. You may have hard measurements of these ratios, or you may have to take a scientific guess at them.

Divide your possible productive hours by your actual productivity rate, or percent, to determine the actual hours you expect to recoup your costs.

Other Costs

Document the wages paid to employees in each of these cost centers. Calculate the wages and total them for an entire year. Also identify the wages paid to employees who supervise the production area but whose wages cannot be pinpointed to one specific cost center. You might allocate portions of these supervisors’ wages to multiple cost centers via a formula that makes sense for your organization.

You must also account for utilities like heat and rent. A common way to break these out is to calculate heat and rent for a year and divide that by the total square footage of the plant. This gives you a rate per square foot that can be easily calculated based upon the square footage for each cost center or overhead area.

Property insurance and personal property taxes for a year may also be allocated to each cost center and overhead area based on some method — usually the method by which these insurance premiums and taxes are paid (e.g., per employee, per value of asset, etc.).

Cost of Benefits

Calculate the benefits you pay for the employees in each cost center for an entire year. Benefits such as the FICA, Medicare, unemployment insurance, worker’s compensation, and other health insurance premiums you pay to employ people should be calculated and allocated to each cost center. You must also be sure to include any supplies or repairs anticipated for a year and any other costs you can identify.

Total all these costs for a year for each cost center or group and divide the total by the actual productive hours you calculated earlier. Voila! You have now calculated budgeted hourly rates for your operation.

This article extremely simplifies the process. As you begin to analyze costs, remember the importance of identifying individual units of cost, totaling them to represent a year, then dividing by the productive hours you predict your team will achieve over the coming year.

When I teach this in class, we build an Excel file that has all the financial facts entered in one place. Formulas are used in all other locations in a way that allows us to change one fact in one place and see the effect on the result. In this way, we can use the Excel file as a living tool from year to year, entering changing costs to easily recalculate hourly costing rates for the following year.