In this article we discuss our recommendations for calculating cost rate.
Standard Cost Rate Recommendation
The benchmark we subscribe to recommends that the project margin is calculated similarly to how gross margin is calculated for the organization. Most professional services organizations put salaries, benefits, and specific expenses related to these People “above the line” in the Cost of Goods Sold (otherwise referred to as Cost of Services) line on the profit and loss sheet. In order to follow that pattern, we recommend that you use the burdened cost for each Person (or the average burdened cost by role) related to the total number of hours available to bill each year when calculating the cost rate.
Some definitions for reference
- Burdened Cost
Burdened cost rate should include the direct costs of maintaining an Person such as: gross compensation (salary, commissions, bonuses, etc), employment taxes, healthcare benefits, pension (including 401K) contributions, training, travel expenses, leave, and any other hidden costs.. The difference between burdened cost and the fully burdened cost is that the fully burdened cost includes an allocation for corporate SG&A costs. Our recommendation is that you use Burdened Cost, not Fully Burdened when calculating the cost rate.
- Total Hours Available
The total hours available is a function of the number hours relative to the organizational standard working days. For example, it would be every weekday (260 days) less the number of PTO days (vacation and holidays) multiplied by the number of working hours expected each day.
260 - (11 holidays + 10 PTO days) * 8 hours = 1912 hours available
- Cost Rate (Burdened Cost Per Available Hour)
Cost rate can be determined by either the individual or role based on the fully burdened annual salary and related expenses (the fully burdened cost) for the Person divided by the total number of hours available in the year.
How do we recommend you add costs?
By Role - If tracking project costs and related contribution margin is a new concept to your organization, we would recommend starting with roles and segmenting by role level or seniority, ie. senior, junior, etc. to get a feel how it works. When you get comfortable working to project margin, then you can start layering in more granular control.
By Individual - As we described above, the recommendation would be to not use individual cost rates until the company is comfortable managing projects with costs and margins in consideration. As the team becomes more comfortable and wants to become more granular, you can layer in rates for the individual. We make this recommendation knowing that it’s a lot of extra work to maintain individual cost rates in the system. We also think it introduces complexity for tracking cost rates as you change people on the project. Ideally, you’d start with something more simple that is directionally correct and work into getting more precise.
Note: We do recommend you use individual rates for contractors where they can be very specific.
We hope this helps. As always, if you have any additional questions or feedback, please do not hesitate to reach out.