How to Calculate Your Agency's True Cost Per Hour
Most agency owners know their billable rate. "We charge $100/hour."
But they don't know their true cost per hour. The real cost includes labor, overhead, taxes, benefits, and everything else.
Calculate this wrong and you're wildly underpriced.
The Components of True Cost
Your true cost per hour includes:
- Direct labor cost - What you pay the person doing the work
- Overhead cost - Rent, software, insurance, utilities spread across hours
- Taxes and benefits - Payroll taxes, health insurance, retirement
- Sales and marketing - Cost to bring in new clients
- Profit margin - What you keep
The Calculation
Let's say you have a 4-person agency:
Team costs (annual):
- Person 1 salary: $60K
- Person 2 salary: $50K
- Person 3 salary: $50K
- Your salary: $80K (you're an owner who also works)
- Total: $240K
Annual overhead:
- Rent: $24K
- Software (Asana, Adobe, etc.): $6K
- Insurance: $12K
- Utilities, internet: $6K
- Accounting, legal: $6K
- Total overhead: $54K
Annual taxes and benefits (assume 20% on payroll):
- $240K x 20% = $48K
Sales & marketing (assume 5% of payroll):
- $240K x 5% = $12K
Total annual costs: $240K + $54K + $48K + $12K = $354K
Billable hours per person annually:
- 2,000 hours available
- 75% utilization target = 1,500 billable hours per person
Total billable hours for 4 people:
- 4 people x 1,500 hours = 6,000 billable hours
Cost per billable hour:
- $354K / 6,000 hours = $59/hour
This is your break-even cost. You need to bill at least $59/hour just to not lose money.
Adding Profit Margin
You don't want to break even. You want profit.
Add your desired profit margin:
- If you want 20% margin: $59 x 1.20 = $70.80/hour
- If you want 25% margin: $59 x 1.25 = $73.75/hour
- If you want 30% margin: $59 x 1.30 = $76.70/hour
Most agencies target 25-30% profit margin, so your minimum billable rate should be $75-85/hour.
But Wait: You're Not Actually Billing All Hours
Not everyone in your agency is billable. You have PMs, admin staff, etc.
Recalculate:
Billable people: 3 (everyone except you, the owner)
- 3 people x 1,500 billable hours = 4,500 billable hours
Cost per billable hour:
- $354K / 4,500 hours = $78.67/hour
With 25% margin: $78.67 x 1.25 = $98.34/hour
Now your true billable rate is closer to $100/hour.
The Simple Formula
Here's a shortcut if you just want the number:
True hourly cost = (Annual payroll + overhead) / (billable hours) x (1 + desired profit margin)
Example:
- Annual payroll: $240K
- Overhead: $54K
- Billable hours: 4,500
- Desired margin: 25%
True cost = ($240K + $54K) / 4,500 x 1.25 = $81.67/hour
Account For Different Roles
Different roles have different costs:
Junior designer cost per hour:
- Salary: $50K annually
- Your utilization share: 75% = 1,500 billable hours
- Just salary cost: $50K / 1,500 = $33/hour
- With overhead and margin: $33 x 1.5 (for overhead and profit) = $50/hour
- Your minimum billing rate for junior: $50/hour minimum, $75-100/hour if you want margin
Senior developer cost per hour:
- Salary: $100K annually
- Utilization: 1,500 billable hours
- Just salary: $67/hour
- With overhead and margin: $100/hour
- Your minimum billing rate: $100/hour, $125-150/hour with margin
Why This Matters
If your true cost is $80/hour and you're billing $100/hour, you have $20/hour margin. On 1,500 billable hours annually, that's $30K profit for one person.
If you're billing $85/hour, you only have $5/hour margin = $7,500 profit. Tight.
If you're billing $75/hour, you're actually losing money ($5/hour loss = $7,500 annual loss per person).
You cannot scale a business that's losing money per billable hour.
The Red Flag: Underpriced Services
If you calculate your true cost and realize you're priced too low, you need to raise rates immediately.
How to raise rates:
- New clients get new pricing
- Existing clients at renewal: "Our rates are increasing to $X effective [date]"
Some clients will leave. That's okay - they were unprofitable anyway
FAQ
What if I'm a solo freelancer?
Your cost per hour includes your salary, home office, software, taxes, benefits, and profit desire.
If you want to take home $60K annually and work 1,500 billable hours: $60K / 1,500 = $40/hour cost.
Add 50% margin for profit: $60/hour minimum billing rate.
Should I bill my time or just team time?
For project work, yes. Your time is valuable. Price accordingly.
If you're spending 10 hours managing a project at your cost ($100/hour), that's $1,000 in costs that should be covered in the project price.
What if my costs are higher than I calculated?
That's common. You probably missed something (accounting costs, tools you forgot about, taxes).
It's good data. Fix your pricing based on real costs.
How often should I recalculate?
Annually. Your costs change (people get raises, overhead increases, team grows). Update your cost calculation yearly.
What if my utilization is below 75%?
Your cost per hour goes up. If you're at 60% utilization, your cost per hour increases by 25%. You either need higher billing rates or better utilization.