Hourly Rate

Calculating hourly rate is an important factor when adding value to your customers. Too high a rate and you may risk losing quotes unnecessarily and too low a rate and you may find you’re losing money. To be perfectly honest, in the early days Amco didn’t understand our own hourly rate and charged our best guess or what the market would allow. We did see our bank balance increase so we figured we were making money. This worked until we discovered as owners we were working the majority of our companies’ hours and we were paying ourselves below market. Nothing wrong with that per se, but it would have helped to manage expectations and know ahead of time. Instead, we got a unwelcome surprise at the end of the year. Of course, we then did go ahead and make the calculation and things became much more clear. We realized that understanding the source of your costs is important, especially when prices fluctuate.

Shops may choose to charge a different rate when they’re machining different materials, using different machine tools or when your insurance increases. Understanding hourly rate goes hand in hand with tracking time to a job and auditing whether or not it was profitable. If a customer asks you to lower a cost and you are able to comply because you review your hours against a quote and there is certainty in your numbers. Or if you think you’re losing money on a job, you can confirm by tracking hours and knowing where your break even amount lies. You’ll be able to make changes on the fly if costs change.

In this article, we calculate hourly rate by summing all our monthly costs and dividing by the number of machinist hours worked. I’ve chosen a shop of 9 staff consisting of 5 machinists and 4 support staff. I’ve estimated costs as best I could. Some values could be argued as too low or too high, but the idea is the same.

The plan is as follows:

• Choose a target month

• Split employees into two groups: direct and indirect

• Sum and average direct employee hourly rate

• Sum the indirect employee costs and add to the direct employee costs

• Sum equipment and tooling costs and convert to an hourly rate

• Sum overhead costs and convert to an hourly rate

• Sum hourly rate costs

• Highlight assumptions and estimations

If the following rate is calculated for one month you’ll get a close estimate, but the more months you calculate over the better your estimate will be because of the variance from month to month. Avoid making this calculation too far in the past for costs that tend to increase. If your time frame is a couple years and your rent has increased since then, you’ll introduce an inaccuracy since rent is unlikely to decrease in the future, but your hourly rate includes the lower cost time frame.

Example Month

February 2022 will be used for our example where here in Alberta, Canada there are 19 working days plus one holiday. In our example all employees work 8 hours per day.

Direct and Indirect Employees

In our example, we calculate hourly rate using some employees that are directly working on a job and others indirectly working at the company, but in more of a support capacity. The direct group will track time to a job and the indirect group will not. If your company doesn’t track time, the direct group would be the ones adding time in your quote. The direct group consists of the 5 machinists while the indirect employees are either supervising, handling administrative roles, or otherwise working at the company.

Direct Employees

As shown above our average hourly cost for our direct employees is $26.12/hr. Let me explain each category. Hourly wage is simply what the employee is paid before any deductions. Efficiency is the amount of time in the day the machinist would spend logged into a job. Here in Alberta, law requires at least 30min of break time in a 8hr shift so automatically the highest efficiency possible is 93.75%. Further time efficiency could be eroded by a lag between jobs, communicating with team members, or a lack of business where the employee is not productive. Efficiency is one of the harder estimates to make, but a critical one. Holiday factor takes into account the 8 hours of holiday paid to employees in February 2022 without productivity. Hourly cost = hourly wage/efficiency * holiday factor. Since we’ve averaged costs for each employee, we treat their hours as the same even though some are more productive or more expensive than others. This is done for simplicity’s sake in order to avoid tracking time for each person to each job. Keeping track of hourly cost for each machinist is certainly possible and more accurate, but it comes with some added burden and complexity. This balancing act of simplicity and accuracy in hourly rate is a common theme through this article which we’ll bring up again. We now have one component of our hourly rate so let’s continue with the indirect employees:

Indirect Employees

Here we’ve summed our indirect employee wages and divided by the number of machinists. By doing so, we’ve spread the cost burden of the indirect employees over the direct employees. Again, we’ve assumed that everyone, indirect and direct employees, works 8 hours per day. So our hourly cost for the indirect employees is $26.33/hr. So far with labor costs for direct and indirect employees we’re at $52.45/hr ($26.33+$26.12). You’ll notice that although we included the holiday factor as with the direct employees, we omitted the efficiency column. We included the holiday factor because the indirect employee hourly wage is spread over the 760 direct hours which does not include holiday. The efficiency has been left out because the indirect employees hours are not tracked to a job but rather their costs are added as a burden to the hourly rate. In contrast, the direct employees efficiency takes into account the hours the employer paid for, but are not tracked to a job. This does not mean that we don’t need the indirect employees to be efficient, it only means that their efficiency isn’t accounted for in the hourly rate.

As previously mentioned, the more employees you have working directly on a job and tracking time, the more accuracy will result, but at the burden of including those hours separately. For instance, in our example, we likely could have the quality inspector in the direct group, but we’d have to estimate inspection hours for each quote. If tracking hours, the inspector would also have that burden. The trade off with many people logging time is the work involved. If a employee has to constantly log in and out every 5 minutes, it will likely be a headache and could even become inefficient. The reader needs to use discretion and choose what bests suits their business.

Equipment

Next we’ll include equipment costs such as machine tool maintenance, depreciation and tooling costs. We’ve assumed there is no financing involved. We need to estimate depreciation on machine tools, add maintenance costs and divide by the number of direct machinist hours worked. The number of machinists hours (direct employees) per month is 760 (152 x 5 = 760) which is used repeatedly for the in this article.

Machine Tools

So machine tool depreciation and maintenance adds another $4.76/hr. I’ve assumed equipment depreciation is 10% yearly and maintenance is 2% yearly as per the top row of the chart. I personally find this calculation particularly insightful. Although machine tools are expensive, the burden of their cost per hour is fairly low because it’s their depreciation that counts into hourly rate and not their upfront cost. However, this low hourly cost can be misleading in an extreme example. Suppose our example shop added a pricey, $1,000,000 machine tool with $100,000 yearly depreciation and $2,000 yearly maintenance, your hourly rate increase is only $11.18/hr. However, since we’re spreading out the costs over all 5 of our machinists, the hourly rate increase of $11.18/hr would be the increase for every machinist, not just the machinist working on the $1M machine tool. Thus you’d have to charge the same hourly rate for the $90,000 machine tool as a $1,000,000 machine tool which wouldn’t make much sense. This is an example where it’s probably best to separate out the depreciation of one machine, since it’s much pricier than the rest and skews the average we calculated.

The deprecation values above are estimates of the real world depreciation of the equipment and are not the accelerated values of depreciation manufacturing companies in North America can use for tax purposes. The depreciation we’re using is the difference of the market prices of the equipment between the purchase and sale.

Let’s move on to the durable tooling cost and depreciation:

Durable Tooling

Durable tooling depreciation is adding $0.59 to our hourly rate. Not a game changer since the amount is low, but an example of how easily one can convert monthly costs into the hourly rate. I’ve assumed a depreciation rate of 12%/year for the durable tooling.

Overhead

Overhead or fixed costs are those that are necessary to run the business but we’re unable to reasonably divide their amounts per hour in real time. Again we’ll sum our costs and divide by the number of machinists hours of 760:

As per our calculations above, the sample overhead costs are result in a charge our of $15.79/hr. Next we’ll sum our values and add a profit markup to achieve our total hourly rate.

Hourly Rate Total

Here we’ve simply summed the hourly costs of each step above and added 20% as our profit margin. Now you’re ready to estimate hours to a job, multiply by your hourly rate, and add material and 3rd party services costs.

Comparing Hourly Rates Between Competitors

So what’s your hourly rate? This question could be asked by a buyer of your services in order to quickly compare between competitors and choose the least costly. Of course, as we’ve just examined, the answer would differ greatly depending on the employees that are involved in the billing of time and those that act in a support capacity. If one shop charges, $90/hr but every single employee in the shop adds time to the job, if could be a greater cost per part than a shop that charges $120/hr but only involves machinists in their time. Thus, it’s best to compare quotes on a cost per part basis rather than hourly rate.

Assumptions

Although this article’s attempt to calculate hourly rate is based on real world costs, there are some that have been left out for simplicities sake:

• Health benefits - no 3rd party health insurance costs

• Vacation - no adjustment for vacation has been taken into account

Amco continuously monitors our costs to provide value to our customers. Contact us to help with your machining needs.