Why it may be getting harder to make money the more you grow your people based business.

Why it may be getting harder to make money the more you grow your people based business.

Miscalculating your employees charge out metric could be why your service business is not making good profits.

Do you run a people based service business? These include garages, consultancies, IT maintenance, dentists just to name a few.

When you start your service business, it normally just involves you working in the business. Many people remember the time they did all the sales, service delivery and even answering the phones. As your business grows, you may employ an admin staff to release your time further. Then there comes the point where you can’t provide your service on your own. It’s time to employ your first member of staff who will help you with the actual delivery of your service.

This is an exciting time! But beware! It is important, as you transition from yourself to a multi delivery team, to get your figures right. You must ensure you calculate the vital metric for charging your employees time out correctly.

Often, in order to attract an employee or subcontractor, you will need to fix the hours that you will be requiring their services a week. This gives surety of work to your employee and can be necessary to prevent him leaving.

However, pay heed! If you do not set the targeted chargeable hours correctly, you could end up over diluting your margins. This creates a much less profitable business model. Lower profits mean you have to work much harder for every sale you make.  You want to ensure you calculate this metric correctly from the start.

Here is a worked example so you can see what can happen.

As Sole owner and worker in the business, the owner charges out 20 hours per week at £60 per hour to his customer.

When he takes on an additional consultant, he agrees that due to the presence of non chargeable work, e.g. holidays, admin, set up costs, scoping and non-billable meeting times etc. he targets his employee to charge out 15 hours out of every 25 hours worked per week. Based on the agreed pay rate to his new employee of £25/per hour you can clearly see how this reduces the gross margin of this business. This falls from 71% when he was the sole worker in the business to 54% after the new employee starts.

We would expect some reduction in gross margin. Looking at the fall of 17% gross margin indicates that the pay rate to the employee could be too high. Alternatively the targeted chargeable hours to customers may be too low. Further negotiation maybe required to ensure that you can maintain your gross margin at a level, which still keeps your business shape viable.

Often when taking on extra resources this will cause a step change in your overheads. Perhaps you incur additional admin costs as more work needs to be processed. You may need to invest more in your marketing to maintain higher levels of sales and so on. It is important to keep an eye on your overall business shape to ensure that the final net profit you make is maintained.

 

Impact of transitioning from Sole worker to Multi worker business.    
         
Sole Worker Additional Total
Rate paid to employee £25
Rate/hour charged to customer £60 £60
Hours worked 37 25
Chargeable Hours 20 15
SALES -Charged to customers per week 1200 £900 £2,100
COST OF SALES -Costs to run the business      
Directors pay taken -350 -350
Employee costs -625 -625
Gross Margin 850 275 1125
  71% 31% 54%
Overheads normally 500 150 650
Profit 350 125 475
Profit/Sales 29% 14% 23%
Available Directors pay £700   £825

 

As director in the business you may feel ‘poorer’. With the new employee, although you have nearly doubled your turnover, your available drawings has not doubled. In fact they have only increased by an additional £125/week.

Getting the metrics right for charge out rates and targeted charge out hours for your employees can make the difference to you as the business owner. If you want to build a sustainable business which eventually you can spend less time managing, setting these metrics correctly is key. In the longer term this will determine if your job is going to get easier! As you grow you must ensure you maximise spare cash and profit. Your business will need to be able to afford more resources for growth and maintaining its existing sales. If it cannot afford these, you will get drawn more and more back into the business.

Calculate these wisely!

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