Wrap Rate

Good source of information on your company’s wrap rate.  What is a Wrap Rate?

I wasn’t familiar with this term- it is apparently related to government contracts. In the non-government world, the term is “fully loaded burden rate” and is not a factor- it’s a dollar amount per hour. Also, a fully loaded burden rate may or may not include profit. The Wrap Rate does include profit.

A couple of things it doesn’t clarify:

The wrap rate is the “fully loaded burden rate” (your final calculation)  divided by the base hourly rate. In their example, $72.47 / $40.00 = 1.81

They separate Overhead and General and Administrative expenses. I wouldn’t worry about making that distinction because there really isn’t any. Treat it as one number- all costs that are not Payroll & Benefits related.

How much Overhead does each Hour of Labor have to absorb?
(Hint: It’s a trick question)

This article also fails to mention how they got those percentages they use for Overhead and G&A expenses. It’s not easy and it’s never exact. They also don’t take into account Utilization, or the fact that not all of your employee’s hours will be billable.

1. Identify what your overhead costs are for the year. Include rent, marketing expenses, bank charges, accounting fees… everything that is not related to an employee’s wage and their fringe benefits.
2. Determine how many hours will be billable for the year.
   1. An employee working 4o hours a week for 52 weeks (an entire year) is 2,080 hours.
   2. If you offer 2 weeks vacation- the employee can only bill 2,000 hours a year maximum.
   3. Some industries use a term called Utilization- the ratio of billable hours to total hours worked. For example, an employee is able to bill 35 hours each week of their 40 hours worked (5 hours is spent on administrative tasks). Their utilization is 35 / 40 = 87.5%.
   4. Your employee has a maximum of 2,080 paid hours per year, less 80 hours of vacation, at 87.5% utilization. That means the employee has 1,750 hours per year that are billable.
3. Determine the employees hourly rate and any fringe benefits (insurance, unemployment taxes, 7.65% FICA & Medicare). Let’s use $40 an hour + 10% for fringe benefits. Employees hourly cost is $44.00. If they are an independent contractor, fortunately you have no fringes and it’s just their hourly rate.
4. So we have two annual costs to work with now:
   1. Total Overhead for the year computed in #1.  For this example, let’s use $50,000.
   2. The annual cost of your employee, which let’s use $44.00 per hour and you are paying him/her for 2,080 hours a year or $91,520.
   3. Overhead plus employee total cost is $141,520.
5. We already established that this employee will only be billable for 1,750 hours a year or 87.5% of the time. So your total costs per billable hour are $141,520 / 1,750 = $80.87. This would be your “fully loaded burden rate”.
6. No we want to build in our profit. Let’s use 10% in this case. So at $80.87 x .10 = $8.87 profit per hour.
7. To convert that to a Wrap Rate, take ($80.87 + 8.87) / $40 base hourly rate to get to 2.24.

Why is this not exact?

Because you are making several assumptions:

1. Are you sure your estimates for overhead are accurate? You won’t know until the end of the year. If overhead costs are lower than your estimates, your wrap rate should have been lower. If they are higher, your wrap rate should have been higher.
2. Will the employee be 87.5% utilized? They might have higher utilization, they might have lower. If the employee has better utilization, that means more hours to bill so you have more hours to absorb costs- wrap rate should have been lower. If their utilization is lower, your wrap rate should have been higher.

The Lesson: Know your overhead costs AND the employee’s utilization

If you don’t take utilization into account, you would get a fully loaded burden rate of $141,520 / 2,080 = $67.90.  Adding a 10% profit, you would get a wrap rate of ($141,520 + 10% x $141,520) / 2,080 = $74.84. Divide this rate by your base hourly rate of $40 to arrive at a 1.87 wrap rate.  On an annual basis, here is what would happen: you would bill $74.84 / hour x 1,750 hours per year or $130,970. Your total overhead and payroll costs are $141,520, so you lost $10,550 on this job. That’s because this calculation ignored the 330 hours that you still paid the employee and the overhead costs were not fully absorbed in the hours worked.

If you bill at $89.74 / hour (from our wrap rate computed in the above section) x 1,750 per year for a total $157,045. This gives you a profit of $15,525 or the 10% you built into your rate.

 

Many entrepreneurs don’t grasp the concept of utilization when selling services and it is crucial to ensuring that you price your services appropriately.  Set up a spreadsheet that allows you to change your overhead costs and the utilization to see how it affects the wrap rate.