Blog
Aaron Rodrigue
If you’re an employee, there are many costs associated with running a business that you might not have considered yet. Before you decide to start a business, (even more importantly if you’ve already started one) you need to build a model of your costs.
If you’re earning income as an employee in Australia, your employer is required to pay you 9.5% extra as superannuation. This means if you’re earning $70,000 a year… your employer is paying and extra $6,650 into your retirement fund. You’re not obligated to pay yourself superannuation if you’re self-employed, but you should consider it. You don’t want to get to retirement age and find out you’ve got nothing there. When starting a business, you should add 9.5% to cover the loss of superannuation you receive as an employee.
Australians take an average of 9 sick days a year. For someone earning $70,000, this adds up to $2,500 – $3,000 a year (before tax) that you’d miss out on when working for yourself. As a rule of thumb, you should add 4% to your hourly rate to cover sick days.
Depending on the state, there are around 11 public holidays a year in Australia. You need to consider that you won’t be paid for the public holidays you don’t work when you run your own business. You should add about 5% to account for this.
If you’re full time you should get paid holidays in Australia, 20 days per year. You’ll need to add around 10% to account for this.
Not every moment of your workday is going to be spent on hours you can bill to your clients. You need to think about the overhead of the administration side of your business. You’ll spend time on marketing, sending quotes and invoices, chasing payments, and traveling to jobs or picking up supplies and equipment. Don’t forget you’re also probably your own I.T. support, office manager, receptionist, and cleaner! A business that is very efficient might be able to get the administration down to 5% of their time, but some businesses can have administration overheads as high as 40%. If you’re just starting out, you should estimate an overhead of around 20% to begin with. You’ll need to go back and measure how much time you spend that’s billed to clients, and how much you spend running the business. If you charge $100 an hour but spend 30% of your time on administration (non-billable hours), you’re really only earning $70 per hour. It’s a good idea to use the time in between jobs to get through your administration tasks so you don’t lose this time because it can add up quickly.
TIP: If you’re changing from being employed full-time to self-employed or contracting, you should add a minimum of 40% to the rate you charge to cover the loss of employee benefits. You need to add more if you are required to use your own vehicle or equipment.
One of the easiest mistakes to make when starting a business is not understanding your material and equipment costs. When working with equipment, it’s important to calculate not just the purchase price, but how long the item will last. A great example of this is when using your own vehicle. You need to include the original purchase price of the car, the cost of servicing and registration, the cost of fuel, and the depreciation in value (how much less the vehicle is worth because of the extra distance it’s driven). Eventually the car may need to be replaced entirely. All of this can add up to a big part of your costs if you’re driving to visit your clients.
Consumables are often more obvious. These are items you use directly on a job. If you’re a hairdresser, this might include shampoo or hair die. If you’re a cleaner, these are things like sponges and window cleaner. This might sound obvious, but you need to estimate how much of these products you’ll use on a job to fully understand your costs. It’s a good idea to work backwards to a per-job cost, even if you don’t put these costs on the client’s invoice.
You also need to budget for other costs in running your business. Do you need to pay for software, hire a web-designer, a lawyer, or an accountant? Try to think about other professionals you might need to assist you in starting and running your business as their costs should form part of your pricing model. You also need to factor in subscription services like phone, internet, electricity, and rent.
Every business carries with it an element of risk. The risk a client won’t pay. A risk of being sued. Maybe your computer crashes and you didn’t make a backup. You’re working on a job site and a tool fails and causes an injury to someone else. Try to think about the risks associated with your business and find out if you can insure against them. In a future post we’ll be talking about professional indemnity insurance (if a mistake you make costs another business or person money), and public liability insurance (if a mistake you make causes damage to property or causes injury). We don’t like to think about things like this happening, but they can be devastating when they do. You should consider insurance to protect you against risk and include these costs when calculating your operating costs. In your model for risk cost you should also include the average percentage of invoices that are never paid.
Once you’ve finished estimating all the different costs for your business it’s time to add them all up. It’s a good idea to lay them out like the simple example below.
Superannuation 9.5%
Sick Days 4%
Public Holidays 5%
Annual Leave 10%
Administration Time 20%
Vehicle Costs 15%
Non-Vehicle Equipment Costs 4%
Consumables 9%
Risk 8.5%
Total 80%
In the example above, we calculated that we need to add 80% to what we charge our clients to cover the operating costs. Put another way, if you’re currently earning $70,000 per year as an employee, you’re earning around $35 per hour. You’d need to charge a client around $65 an hour just to be in the same financial position.
So, you’ve figured out an estimate of all the costs associated with your business. What next? The most important thing to do is to keep track of your costs as you run your business to see if your estimates were correct. All modern accounting software will let you record your businesses expenses and report on them over time. This is the best way to see if what you think you’re spending to run your business really adds up.
Stay tuned for upcoming posts that will cover taxes (another important part of calculating your costs), and figuring out how much to charge...
One of the most important things to do before you start a business is to understand what your costs are, so you know how much you need to charge, and how much you’re going to be left with after the costs of running the business.
