This seems to cause the greatest problem with new businesses. People often price their services based on what their competition is charging, what they think their customers are willing to pay or by some rule of thumb such as total cost is three times materials.
The fact is that if you price too high you will not get any jobs. If you price too low, you will go out of business. So how do you figure out what to charge?
Let's start at the top and work our way down.
You receive from your customers a certain amount. This is your gross receipts or total revenue. From your total revenue you have to pay variable costs for each job, such as materials and subcontracted labor. From this amount you then have to pay your fixed costs such as employee wages, insurance, rent, utilities. Whatever is left is your business income. Eventually this business income is either reinvested in the business or withdrawn as a salary. This salary then has to pay your personal expenses such as your mortgage, utilities, insurance, groceries, tuition, etc.
To determine your billing rate you need to work from the bottom up.
First determine the minimum salary you need to support yourself and your family. Add up your monthly expenses including mortgage payment, rental payment, car payment, auto insurance, health insurance, gas, oil, electric, phone, cable, water, etc. Also include a sufficient amount for groceries, eating out, clothes, medicine, recreation, etc. From this you might determine you have a need to make $4,000 per month.
Next determine the amount you need to pay your fixed business expenses, i.e. overhead. This would include employee salaries, accountant fees, lawyer fees, phone, workers compensation insurance, business insurance, truck payment, fuel, vehicle maintenance, tools, equipment, advertising, bank fees, office supplies, bookkeeping services, payroll services, etc. From this you might determine your fixed expenses are $1,000 per month.
Now you need to make each month a total of $5,000 to cover your business and personal expenses. From this you could calculate that you need to make $1,250 per week. Keep in mind we still have not added any variable costs.
Now if you need to make $1,250 per week you could simply divide that by 40 hours to get a billable rate of $31.25 per hour. However, that is where business owners go wrong.
The next step is not budgeting your money but budgeting your time. In a given week how much time is spent actually providing your service? How many hours can you actually bill the customer for? So from your 40 hours you need to subtract time spent doing paperwork, doing your banking, balancing your check book, marketing your business, doing estimates for customers, buying materials, going to the store, getting your vehicle repaired, running personal errands, going to lunch, meeting with your employees, talking to your lawyer, talking to your accountant. In general only 50 to 60% of your working week is spent working. The statistics tell us that the average employee only works 4 to 6 hours per day. Often working longer days does not significantly increase the amount of actual work hours. It just increases the amount of time spent not working.
So now perhaps you have calculated that you actually work about 30 hours per week. Now your billable rate is $1,250 over 30 hours or $41.67 per hour.
So when you are estimating a job you would do the following.
Determine the number of hours the job will take.
Multiply that number by your hourly rate.
Then add your variable costs such as materials and subcontracted work.
This is then the total you should charge for the job.
So if a job would take 50 hours, and your hourly rate is $41.67, then you would charge $2,084 plus your materials of $800 and your subcontracted work of $200 for a total of $3,084 for this hypothetical job.
What if the rate you determine per hour is too high?
Perhaps it is higher than your competitors charge. Perhaps it is more than you think your customers are willing to pay. One strategy is to simply charge the lower amount and hope for the best. This is a common strategy. Guess what happens. You will go broke. But at least you kept real busy while that was happening.
Your only sane options are to
Lower your personal expenses, e.g. don't go out to eat as much
Lower your overhead expenses, e.g. fire an employee, get a cheaper truck
Bill more hours, e.g. work more hours or get more jobs done per hour
Have an Excellent Product.
If you do excellent work, then you can charge more than your competitors. You will also tend to attract customers that are more concerned with quality than price. The other options involve tightening your belt or working harder than you already do.