11 – Work out your hourly rate and your breakeven point
Regardless of how you decide to price your services, the first thing to do is to calculate your breakeven point.
This figure should include your targeted rate of return.
Just to be clear, and to save you asking, the breakeven point is the point at which you earn as much as it costs you to be in business. This is the point of inflection between making a loss and making a profit. If you do not meet your breakeven point, you make a loss. If you exceed the breakeven point, you make a profit.
The breakeven point is, therefore, the minimum required revenue point. If you do not make this, you do not stay in business long.
When it comes to pricing, you therefore need to ensure that the combination of your prices and the number of clients moves you past your breakeven point. Of course the eventual aim is to move as far past that point as possible.
Many people calculate the breakeven point as an hourly rate for all fee generating staff. This kind of hourly figure is much more useful than a breakeven point for a longer period of time, such as a month or a year.
To use a simple example: in a sole adviser practice with one support staff, the hourly breakeven rate is calculated by dividing all the costs by the number of hours to be worked each year. The costs include everything: staff wages, rents, professional affiliations, etc. Let’s say that these costs are $100,000 a year. The adviser is happy to work a 40 hour week, 46 weeks of the year. This is 1,840 hours per year. The hourly cost that needs to be covered by the fee generating adviser is therefore $55 per hour ($100,000 divided by 1,840 hours).
If the adviser charges this, and they can bill clients for 40 hours per week for 46 weeks of the year, the practice will break even.
Of course, breaking even just means not making a loss. It does not mean making a profit. There is no profit in a fee of $55 per hour. The adviser decides that they are aiming for $150,000 profit per year. This implies an hourly profit of $82 per hour ($150,000 divided by 1840). Combined with the breakeven point, the hourly rate becomes $137 per hour: $55 of costs, and $82 of profit.
But there is another catch: this is the required rate if the adviser is fully booked 40 hours a week, 46 weeks of the year. This is unrealistic: when does the adviser do things like their Dover CPD if they are doing client work 40 hours a week? So, now let’s say that the adviser thinks that they can bill 70% of their actual available working time. The required hourly rate from clients now becomes $195 per hour (that is, $137 per hour divided by 70%).
There are 1,840 work hours available. If the practice does chargeable work for 70% of them, this equates to 1,288 chargeable hours. 1,288 times $195 per hour is just over $250,000. This will leave a profit of $150,000 once the $100,000 of costs are taken care of.
This figure can now be used as a basis for all pricing decisions. This is the case regardless of whether the practice will use a time-based system or not.
If the practice does use a time-based system, then the process is simple: clients are simply charged $195 per hour. If the practice uses a project fee model, where the client is charged an agreed flat fee for a given piece of work, the figure of $195 can still be used as the minimum basis of the quoted fee. If the adviser predicts that the work will take ten hours of her time, then the quoted fee needs to be at least $1,950 (plus GST) if she is going to meet her targeted income.
The figure can also be used to calculate the minimum FUM that an adviser will be prepared to offer services for under FUM-based pricing. For example, let’s say an adviser wants to use a FUM-based model and offers clients four two hour meetings a year, including time taken in preparation and follow up. This is eight hours a year. The minimum required income per hour is $195. Multiplied by eight, this means that the minimum fee for this service becomes $1,560. The adviser proposes a FUM-based fee of 0.5% of FUM. $1,560 is 0.5% of $312,000. Therefore, the FUM-based model will only work if the client has more than $312,000 in FUM. For FUM balances less than this, the adviser will not be achieving the targeted rate of return if he or she charges an amount equal to 0.5%.
For example, if a client has assets of $100,000, then the FUM-based fee will be $500 per year. For eight hours work, this represents $62.50 per hour. Given a breakeven point of $55 per hour, this means that the adviser is working for $7.50 profit per hour.
To address this, when a client has a relatively low balance, many practices use a combination of project fees and FUM-based fees. The practice might offer four two-hour meetings a year for a project fee of $1,560 for clients with balances up to $312,000. For clients with assets, above $312,000, the practice instead charges a FUM-based fee of 0.5% of FUM.
This lets the practice avoid the inherent disadvantage of using a FUM-based pricing model for with clients with low FUMs, while allowing the practice to access the inherent advantage that FUM-based pricing brings when clients have large FUMs.
The hourly breakeven amount can even be used by practices which rely largely or solely on commissions. Most practices become quite good at calculating how much time it takes to write a life insurance policy. Let’s say it takes four hours for a cleanskin client. If the breakeven profit figure of $195 is used, then the practice will not achieve its targeted income on any policy for which the commission is less than $780. Some practices might then express their prices by saying that the fee for writing a cleanskin policy is the commission or $780, whichever is the greater.
Whichever system is used, the key is for the practice to first work out the hourly cost, per fee-generating staff member, of being in business. This figure should include the required rate of return for the adviser. This hourly cost then becomes the basis for all pricing decisions for the practice.