What it means
The rate is built from the cost side first. You take what the employee costs in salary, benefits and payroll taxes, add a share of overheads such as rent, software and management time, and then divide by the hours that can realistically be billed.
The last part is the catch. A person employed for 2,000 hours a year does not bill 2,000 hours, because holidays, training, admin, sales and quiet periods eat into the time.
The share of hours that clients actually pay for is called the utilisation rate, and a typical range is 60% to 80% depending on the role. Margin comes next.
Once the cost per chargeable hour is known, the firm adds the profit it needs, which could be a percentage of cost or a target return on the owners' time. Market reality then pushes back.
Clients compare quotes and have a feel for what an hour of a particular skill is worth, so the calculated rate is tested against what competitors charge and what the work is worth to the client. Chargeout rates differ by seniority.
A partner's hour costs more than a junior's hour, and a blended rate for a project reflects the mix of people expected to work on it. Finally, the rate is a management tool and not only a price.
Comparing the hours worked, the rate and the fee collected for each job shows which clients and services make money and which ones drain the team.
In practice
Real-world examples
Example 1
A small accounting practice works out that its senior bookkeeper costs $60,000 a year including overheads and bills 1,200 hours. With a 20% margin the rate comes to $60 an hour, which the practice rounds up to $65 to reflect market norms. The owner reviews it again after a year of time records.
Example 2
A marketing agency sets a blended chargeout rate of $120 for a website project, based on a mix of designers at $100 and developers at $150. It uses the rate to estimate a project fee and to monitor whether the team stays within budget. If actual hours exceed the estimate, the project manager is alerted before the fee is overrun.
Example 3
An architecture firm finds that its junior staff bill only 55% of their hours because of heavy training demands. Raising the rate would price the firm out of the market, so it increases utilisation by reducing admin tasks instead. She also moves some of the routine work to a cheaper team member.
Think of it
Think of a chargeout rate like the menu price at a restaurant. The price per meal must cover the cost of ingredients, the chef's wages, the electricity for the ovens, rent for the dining room, and still leave enough money over for the restaurant owner to make a profit.
Formula
Calculation
Chargeout rate = (Employee cost + Allocated overheads) x (1 + Target margin) / Chargeable hours
A consultant costs $90,000 a year in salary and benefits, and the firm allocates $30,000 of overheads to the role. The firm wants a 25% margin on cost, and the consultant is expected to bill 1,500 hours a year. Chargeout rate = ($90,000 + $30,000) x 1.25 / 1,500 = $150,000 / 1,500 = $100 an hour. If the consultant bills only 1,200 hours, the same $150,000 target would require $150,000 / 1,200 = $125 an hour.Case study
Seen in the real world
Brightmark Advisory is an illustrative, fictional consulting firm with eight staff. The owner priced work at a flat $90 an hour for everyone, a figure she had picked when starting out five years earlier.
When she finally calculated the true cost, she found that her senior consultants cost about $85 an hour before profit once non-billable time was included, leaving almost no margin. Junior staff, who were cheaper but also billed at $90, were making a healthy profit that hid the problem.
She introduced three tiers of $75, $110 and $150 an hour, matched to seniority and market rates, and tracked utilisation monthly. In the illustrative result, profit margin rose from 4% to 14% in a year without losing any major clients. The tiered rates also made quotes easier to explain to clients.
Watch out
Common mistakes
- Setting the rate from salary alone and ignoring overheads, so that the firm bills at a loss without realising it.
- Assuming all paid hours are chargeable, when utilisation is rarely above 80%.
- Copying a competitor's rate without checking whether your own cost base supports it.
Questions
People also ask
Is a chargeout rate the same as a salary rate?
No, because the chargeout rate includes overheads, profit and unbillable time, so it is typically two to three times the hourly salary cost.
How often should rates be reviewed?
At least once a year, or whenever salaries, overheads or utilisation change materially.
Should I discount the rate for large clients?
You can, but work out the effect on margin first, since a 10% discount on a thin margin can wipe out most of the profit.