Common Sense Calculations - That are 100% Wrong

Common Sense Calculations - That are 100% Wrong

Lessons Learned Episode 7 - Common Sense Calculations

This is the story of three money calculations I used early in my consulting, and what became of them. 

First calculation: How much could I make? 

This starts with, what to charge per hour. As with most new businesses, I had no idea what to charge. My background included large, high-end businesses and selling my services to one full-time client at a time. So the world of "trading dollars for hours" was new to me.

I did some basic calculations. And for no good reason whatsoever, I started charging $100 per hour. This wasn't based on anything except it was a nice round number. This was Northern California in the late 1990's. I didn't know that basically no one charged that much.

So - How much could I make? My foolish calculation was:

At $100 per hour

and 40 hours per week

That's $4,000 per week

Times 50 weeks is an easy $200,000

Uh huh. You may have made the same foolish calculation. It took me a long time to make $200K - and that's not how I made it.

What's wrong with that calculation?

First, billing forty hours is nearly impossible, especially for the owner. Busting my butt, I sometimes managed to bill twenty hours. But I didn't charge for sales meetings, for drive time, or for all the time I took figuring out how to source hardware and software. And, of course, I didn't charge for the time I spent marketing and dealing with the overhead of running a business. 

Second, I made the same mistake many of you made by discounting larger projects. I should have added ten percent for all the hassles. Anyway, my average billing rate was closer to $80 on many jobs, and probably $90 on average.

Still, I *did* bust my butt and found lots of little jobs. I made about $60,000 in labor my first year. But it was very hard work. And the cash flow was irregular, so quarterly taxes were a bit painful.

Eventually . . . I learned to never discount my hourly rate until I was prepaid for blocks of hours. That included prepaid project labor. I limited discounts to 15%, and stayed with a standard rate of $100. Therefore, the lowest actual rate was about $85.

Second calculation: How much can I spend?

It takes money to run a business. And every once in awhile, I would look at printing or marketing programs, and I needed to determine whether I could afford them. My big mistake was to look at each individual purchase and say to myself: "That  only costs me one hour of labor." In other words, how much do I need to bill to make this purchase?

Of course, humans are supreme at justifying decisions they want to make. Do you see the mistake I already made? I was telling myself that I needed to sell one or two or three hours to justify a purchase - at $100 per hour. But we just saw that many hours were not sold at that.

I also didn't keep track of the promises I'd made myself. Four hours of labor buys a good printer. One hour buys a mailing. Half an hour buys a book. Seven hours buys a conference.

I need to keep a running tally of the one-time and recurring expenses. I do now, of course. But not at the beginning.

I realized that it was easy to over-justify how many hours I could bill on a whim!

It is always a challenge to truly determine whether you should buy something for your business. It gets easier over time. But the real cost, and the real ability to pay for it, are still based on a certain level of speculation.

Third calculation: Profitable markups

This was a hard lesson. But once I learned what works for ME, I never had to re-do it. 

I started out paying attention to the price of things being sold to the general public. For example, if a printer sold for $400, then I thought I had to be at that price or lower. But guess what? Distributors wanted to charge me *more* than that because I don't have bulk pricing. How do I compete with Office Depot and other big box stores?

My early calculation was to only sell hardware if it was combined with labor. That way, I'd try to get my margin out of the labor. But that means that 1) I was lowering my labor rate once again, and 2) I didn't account for the labor it took to research, find, buy, and deliver the hardware.

Luckily, my tax advisor was a pretty good business advisor as well. He made the separate hardware and software from everything else in QuickBooks - on both the revenue and expense sides. This way, I could see at a glance the total hardware sales and the total I paid for hardware over the year. These numbers were almost identical, which meant I had no effective markup.

At this point, I knew a few other consultants and asked them what they did with markups. Some claimed to charge 100% markup. But they also admitted that they got pushback from some clients. Some charged 20%, some 30%, and some charged the MSRP (manufacturer's suggested retail price) and made their profit by beating up their distributors.

Eventually, I realized that 1) I can charge whatever I want as long as 2) I accept that some people won't buy from me. I decided on a simple calculation: I charged roughly 25% than I paid for an item, whether hardware or software. Thus, if I paid a distributor $100 for a product, I sold it for $125. And, thus, 20% of the final price was my margin or profit.

Note: This hard, fast rule allowed me to completely ignore MSRP. If I paid $1,000 for a desktop computer, I sold it for $1,250. Period. If the client could buy it somewhere else for $1,100, that was not my problem. I stopped looking and comparing prices. Sometimes I was above MSRP and sometimes below it. 

On VERY rare occasions, a client would ask about pricing. I simple tell them,

1) I do a lot of research to sell you the right thing

2) I only sell business class equipment with a three year warranty

3) I guarantee that what I sell you will be trouble-free. That's the business we're in.

On VERY rare occasions, clients bought things on their own. Almost every time, that resulted in a great story to tell friends over beers one day.

-- -- --

Ultimately, you need to make same mistakes and find a pathway that's sustainably profitable. And somewhere along the way, you'll realize that it's a complete waste of time to worry about what other people charge. All the time and attention you put into learning about your competition is time that should be spent on your existing clients!

Stay tuned for the next installment: The Absolute Truths about Backups!

:-)