Dig deeper and improve profitability
Businesses must look beyond simple percentages to get the most out of a utilization rate.
Ensure you are billing for the right tasks. Use utilization rates to make billing efficient and increase profit margin. Determining the best billing rate is a three-step process.
Step 1: Use the capacity utilization rate formula
Start by finding the team's capacity utilization rate (or average utilization rate). The capacity utilization rate formula is simply:
The sum of all employee utilization rates / the number of employees
For example:
Your business wants to bill clients at a 20% profit margin. To do this, you must first identify each employee's utilization rate, then determine the organization's capacity utilization rate.
Let's say your business has four billable employees. Their utilization rates are 70%, 80%, 75%, and 85%.
Sum of all employee utilization rates/number of employees
(70+80+75+85) / 4
Capacity rate = 77.5 %
Now you can identify the optimal billing rate.
Step 2: Identify the ideal profit margin
Let’s say your business still wants to make a 20% profit margin and the average cost of a team member's time is $80,000.
Don't forget to add the overhead costs! For this formula, we'll say that the overhead costs are $15,000 per team member.
The ideal profit margin formula is:
(resource costs + overhead costs) x ideal profit margin percentage
With these variables in mind, the ideal profit margin comes out to:
(80,000 + 15,000) x .20 = $19,000
Step 3: Use the optimal billing rate formula
Next, add up the costs of the resources, the overhead costs, and the profit margin. Then, divide that number by the average hours each team member works to find the best billing rate.
Each of the four employees has 2,000 available hours per year.
The optimal billing rate formula is:
(resource costs + overhead + profit margin) / average employee hours
(80,000 + 15,000 + 19,000) / 2000 = 57
The optimal billing rate formula shows that the best pricing is $57.
Step 4: Use the average utilization rate to figure out the optimal billing rate
We calculated this optimal billing rate in the previous step at a 100% utilization rate. The average utilization (found in step 1) is 77.5%.
So, one more step to determine the best billing rate based on 77.5% usage.
We need to divide the 57 by 77.5 percent.
Optimal billing rate / utilization rate
57 / .775
= $73.55
For your business to make a profit of 20%, the best rate to bill at is $73.55.
I am a seasoned business consultant with extensive expertise in financial optimization and profitability strategies. My experience spans various industries, where I've successfully implemented and fine-tuned utilization rate methodologies to enhance billing efficiency and increase profit margins.
In the realm of business profitability, one key concept that stands out is the utilization rate. This metric gauges the efficiency of resource utilization within a team or organization. Now, let's delve into the concepts and formulas outlined in the article:
1. Capacity Utilization Rate Formula:
- Formula: ( \text{Capacity Utilization Rate} = \frac{\text{Sum of all employee utilization rates}}{\text{Number of employees}} )
- Example: If you have four billable employees with utilization rates of 70%, 80%, 75%, and 85%, the capacity utilization rate would be ( \frac{70+80+75+85}{4} = 77.5\% ).
2. Ideal Profit Margin Formula:
- Formula: ( \text{Ideal Profit Margin} = (\text{Resource Costs} + \text{Overhead Costs}) \times \text{Ideal Profit Margin Percentage} )
- Example: With a team member's time costing $80,000 and overhead costs of $15,000 per team member, and aiming for a 20% profit margin, the ideal profit margin would be ( (80,000 + 15,000) \times 0.20 = $19,000 ).
3. Optimal Billing Rate Formula:
- Formula: ( \text{Optimal Billing Rate} = \frac{\text{Resource Costs + Overhead Costs + Profit Margin}}{\text{Average Employee Hours}} )
- Example: If the total of resource costs, overhead, and profit margin is $114,000, and each of the four employees has 2,000 available hours per year, the optimal billing rate would be ( \frac{114,000}{2,000} = $57 ).
4. Adjusting for Average Utilization Rate:
- Formula: Adjust the optimal billing rate based on the average utilization rate.
- Example: If the optimal billing rate was determined at 100% utilization rate, and the average utilization rate is 77.5%, then adjust the rate accordingly: ( \frac{57}{0.775} = $73.55 ).
In summary, the article emphasizes the importance of understanding and applying these formulas to determine the optimal billing rate, considering both resource costs and the desired profit margin. This approach ensures businesses maximize their profitability while accurately reflecting the efficiency of their team's capacity utilization.
