Break Even for Services
Ever wonder why break even is done for products? Because it
is easier. True story. Let’s fix some costs as fixed, then produce a widget. (A
widget is a made-up term used as a fictional, generic product). Then take out
the cost of the product and apply the rest to the overhead and done!
But how do you do this for a service? There is no widget.
The product is an idea. Maybe you are a landscaper and produce a design for a
garden. Maybe you are a hair stylist and produce a haircut. Maybe you are a
lawyer and go to court. There are things here that cost money – blueprint
designs, product in a hairstyle, paper documents – that aren’t the real
products. They are ancillary to the real product, which is the know-how.
One of the stories I hear all the time on the internet is
that if you hire an artist to draw a picture and it takes them five minutes to
draw the drawing, you aren’t paying for the five minutes; you are paying for
the years it took them to learn how to draw that well. This is too true, but
more. It’s also the time it takes for the artist to run their business, do
their taxes, organize their supplies, and create pitches, including the pitches
that aren’t successful. All of these things take time, but many aren’t directly
relatable to a project, so they become fixed costs.
Now, what makes things difficult is that a lot of this
thought work, while it can be quantified, it’s hard to be valued. Because these
values are what you are trying to figure out. You can’t build your break even
until you know the value of your hour. But to know the value of your hour, you
need to know how much overhead costs.
To put this another way, your fixed costs, like the cost of
office space, is set like a physical product, but thought time is less easy to
set. Plus some projects are small and some are larger. So if we apply the
physical project model to a service, we would take out the three dollars for
the paper of the project, and then any other dollars would go to fixed costs,
right? Well, as we said earlier, not so fast.
Services often take thought work that has research or
proposal building. Sometimes that is easy to track against a job but not
always. So for instance, if you are a lawyer, and you have a client on
retainer, then you research something for a case, you can bill that client for
the time. But often there are tasks that cannot be tracked against a specific
account, so what do we do for these hours?
In the end, we guess. I know that doesn’t sound very
accurate or business-like, but that’s it. Different industries and professions
will have different numbers but they will all be there. What numbers? The main
number we are looking for is the number of billable hours to non-billable. To
simplify, think of billable hours as widgets, and non-billable hours as the
fixed cost.
The biggest issue with services is that you need to know
your salary or at least profit target to set up a usable and workable model.
This is because many thought products have little variable costs, and even
during non-billable hours, there are often few costs associated, and most of
the work is in your knowledge.
So for instance, you know that on average you’ll spend about
8 hours of your 40-hour week doing non-billable tasks. This means that twenty
percent of your time will be non-billable. That also means the other 32 hours
need to support those 8, as well as the lights, rent, and other fixed costs. I
didn’t mention it in the products post, but you should be paying yourself, at
least on paper. This means pay yourself, even if you have to write yourself
IOUs or add to your accounts payables. Now, take your fixed costs, add in
twenty percent of your salary, then divide by 32. Also, don’t forget to include
your salary in the variable cost per hour.
To put this in an equation, it goes like this: if you want
to make $50,000 a year. Divide this by 50 for a 50-week year, taking out two
for vacation, and you need to make $1000 a week for your salary. Now, divide
that by 40, and you get $25 an hour. For the ease of this equation, let’s say
you have $5 an hour in extra variable costs. So you need to add the $5 to the
$25 and we get $30 an hour, so that’s what you need to charge every hour,
right? Not so fast.
Then let’s say we have $1000 a month in rent and $100 a
month in electricity as our only fixed costs. But then we also need to account
for the non-billable hours too. So 8 hours a week at $25 dollars an hour is
$200. Let’s add up fixed costs, and we get a total of $1,300. To pay for this,
we need our 32 billable hours to cover it. So let’s take out $1,300 and divide
it by 32 which gives us $40.63. Now we need to add that $40.63 to the $30 from
before, and we get $70.63. This is how much you need to charge per hour to pay
for your fixed costs and the variable costs.
This is another area where we need to use estimates and
things like non-billable costs can vary, and would then vary the calculations,
so you have to use your best guess, track where you are spending your time, and
refine your calculations as needed. Many things in business follow this same
pattern. Use our best guess to build a model, run the model in the real world,
gather our results, and refine it. I often joke that the numbers in our models
are wrong the moment we write them because they will be. Sometimes they are
slightly wrong, and we see an eleven-point shift versus a modeled ten-point
shift. Sometimes they are way off; think of any spectacular product flop.
So don’t feel bad if your model is wrong, but it highlights
the importance of both modeling and tracking results. Without the model, we
can’t set a benchmark, and without tracking, we don’t know how we are doing
against our benchmark. And usually, the tracking tells us far more than simply
if the model is wrong; it often highlights where. For instance, we believe a
marketing campaign is going to be viewed by 1000 people, driving 100 to come to
our website, and 10 to buy. We can use tracking to understand where our numbers
are off as fixing the issue of not converting people who visit the site to
sales and the ad not driving people to the site are two very different
solutions.
Speaking of keeping track of things in a horrible clunky
segway, let’s talk about the importance of organizing tools and parts during a
project. Right now, I am replacing the engine in my 2002 Cavalier. Eight or so years
ago, when I got into racing, I could only change oil and brakes. The idea of an
engine swap would have floored me, but I’ve learned a lot. Maybe I should use
this as an entrepreneur analogy sometime. It’s not all at once, it’s a little
bit here and a little bit there, and next thing you know, you’ve done something
big, but that is for a later time.
Let’s get back to tracking. The thing is when I’ve been
working on the car, it’s been a little here and there as I have time. The issue
is, right now, I can’t move forward, not because I don’t have the knowledge of
what to do, but because I have lost about three of the bolts that I need,
including one to the lower engine mount. Now stuck to the front fender are not
one, nor two, but three of those little magnetic bowls where I am supposed to
put things like this to hold them, but I obviously haven’t used them.
So using them would be a start, but what is the best way to
track parts and tools? One common way used
that I like is a simple piece of cardboard. Stick the bolt, screw, or
other parts in the cardboard, as in punch it through the cardboard, and then
label it. If you want to get fancy, you can use different colored sharpies to
write where the part goes and if you can, make a mark on whatever you are working
on in the same color.
But many parts are odd shapes and can’t be punched through
cardboard or are too large. In this case, I usually use a large box and
quart-sized ziplock bags. The bags are great to write on so you can describe
where the part came from. If you want to get really fancy, you can take a
picture of the part/bolt/screw, then mark on the bag the picture number from
your phone. It’s tim- consuming, but not as time-consuming as having extra
parts when you’re all done and trying to figure out where they go.
Here is a video of several different techniques someone uses
on a car, but several of them would work just as well for jobs around the
house. https://www.youtube.com/watch?v=KoaKwWZ97HI
I’ve also seen folks use tackle boxes, accordion folders, and tape to track
parts. You need to find what works for you.
Because in the end, the greatest tracking system doesn’t
work, if you don’t use it. Take it from a confused man who has been walking
around his garage for a week looking for bolts that should be in a magnetic
dish on the fender. You can’t go back in time and track it. It has to be done
in the moment, which may slow you down initially, but in the end will help
speed up results.