Guides
How to Calculate Your Shop Rate
The shop rate formula, the productive-hours error that understates it by about eight dollars, the markup and margin trap, and when one rate is not enough.
Quick answer: shop rate equals annual overhead divided by productive hours, plus loaded labour cost, all divided by one minus your target margin. Almost every shop that calculates a rate too low does it by dividing across paid hours instead of productive hours, and the gap is usually somewhere near eight dollars an hour.
The Formula
Shop rate = ( (annual overhead / productive hours) + loaded labour per hour )
/ (1 - target margin)Four inputs, and three of them are easy. The one that decides whether the answer is right is productive hours.
Step One: Annual Overhead
Everything it costs to keep the doors open that is not the wage of someone turning billable work.
- Rent, mortgage or lease on the building and the yard
- Utilities, and welding draws more power than most budgets assume
- Insurance, meaning liability, property and equipment
- Equipment lease, depreciation and repair, including the crane and the forklift
- Consumables, gas, wire, discs and tips, which most shops expense and then forget to recover
- Administration and office salaries, meaning anyone not turning billable hours
- Software, phones and internet
- Vehicles and fuel
- Professional fees, safety and certification, including CWB, ASME, WCB and audit costs
On the owner’s salary. Split it. Hours spent turning billable work go in direct labour. Hours spent quoting, selling and managing go in overhead. Putting the whole salary in one place distorts the rate in a direction you can predict and will not notice.
Step Two: Loaded Labour, Not Wage
The wage is not the cost. Loaded labour is the wage plus burden, meaning CPP, EI, workers compensation, vacation accrual and any benefits.
Burden commonly runs 18 to 25 percent in an Alberta shop. At a $38 wage and 22 percent burden, loaded cost is $46.36 an hour. Quoting off $38 loses eight dollars an hour before overhead is even considered.
Step Three: Productive Hours, and the Error That Matters
This is the step that decides the answer.
You pay for 2,080 hours a year per person. You cannot sell 2,080 hours. Between statutory holidays, vacation, sick time, training, safety meetings, cleanup, waiting for material and walking between jobs, the sellable figure is a good deal lower.
| Hours | |
|---|---|
| Paid hours per person | 2,080 |
| Less statutory, vacation, sick | 240 |
| Less training, meetings, cleanup, waiting | 300 |
| Productive hours | 1,540 |
| Utilisation | 74% |
Now watch what the choice does, on a six-person shop with $270,000 of overhead:
| Divided by productive hours | Divided by paid hours | |
|---|---|---|
| Total hours | 9,240 | 12,480 |
| Overhead recovered per hour | $29.22 | $21.63 |
| Plus loaded labour | $46.36 | $46.36 |
| Cost per hour | $75.58 | $67.99 |
| Shop rate at 12% margin | $85.89 | $77.26 |
$8.63 an hour. Across 9,240 productive hours that is roughly $79,700 a year of overhead never recovered, on work quoted correctly and delivered correctly.
Be honest about the deductions. Shops that want a lower rate get one by assuming utilisation they do not achieve, and the arithmetic obliges. Utilisation above about 80 percent in a job shop usually means cleanup and waiting are being counted as productive.
Step Four: Margin, and the Markup Trap
The last division catches people who have been in business for decades.
Markup is calculated on cost. Margin is calculated on price. They are not the same number.
| You want | You might do | You should do | Result |
|---|---|---|---|
| 30% margin on $100 cost | $100 x 1.30 = $130 | $100 / 0.70 = $142.86 | The first yields only a 23% margin |
If you have been marking up when you meant to margin, you have been undercharging by that difference on every job you have ever quoted. It is worth checking today.
When One Rate Is Not Enough
A single blended rate is fine while your mix stays consistent. It starts cross-subsidising the moment one work centre gets busier than the others.
Our industrial operations guide covers equipment cost allocation, which is the same question seen from the asset side.
Consider separate rates when work centres cost genuinely different amounts to run. A CNC machine carrying lease payments, tooling and power draw does not belong on the same rate as a hand welding bay with a machine and a table. Nor does a paint booth, a press brake with expensive tooling, or an overhead crane bay.
The test is simple. If you moved an hour of work from one work centre to another, would the cost to your business change materially? If yes, they want different rates.
Check Your Rate Against Reality
Two sanity checks worth running once you have a number.
Against your own history. Take last year’s revenue and divide by the productive hours you actually sold. If that figure is well below your calculated rate, you are discounting more than you think, or recording fewer hours than you sold.
Against the market. Your rate has to be defensible in your area. If the calculated number sits far above what customers pay, the answer is rarely to cut the rate. It is usually that overhead is too high for the volume, or utilisation is worse than it should be. Cutting the rate treats the symptom. Our Edmonton software planning guide covers measuring utilisation properly before changing anything.
Do It With a Spreadsheet First
Our job costing spreadsheet has a Shop rate tab that runs this arithmetic and shows you what the productive-hours error would have cost in your own numbers. Free, no sign-up.
Once the rate is right, the next question is whether your jobs actually cost what you assumed. That is job costing, and for a fab shop the metal fabrication guide covers where the money actually goes.
Frequently Asked Questions
- What is the shop rate formula?
- Annual overhead divided by productive hours, plus loaded labour cost per hour, then divided by one minus your target margin. Written out: shop rate equals ((overhead / productive hours) + loaded labour) / (1 - margin). The two places it goes wrong are using paid hours instead of productive hours, and marking up from cost instead of dividing by one minus the margin.
- What are productive hours?
- The hours you can actually sell. Take paid hours, then subtract statutory holidays, vacation and sick time, and subtract training, meetings, cleanup, waiting for material and moving between jobs. A tradesperson paid 2,080 hours a year is commonly productive for somewhere between 1,400 and 1,600 of them. Anyone claiming 90 percent utilisation is either measuring wrong or not counting cleanup.
- What is the difference between markup and margin?
- Markup is calculated on cost and margin is calculated on price, and confusing them costs money on every job. A 30 percent markup on $100 of cost gives $130 and yields a 23 percent margin. To actually earn a 30 percent margin you price at $100 divided by 0.70, which is $142.86. Shops that mark up when they meant to margin undercharge by that difference on everything they sell.
- Should we have more than one shop rate?
- If your work centres cost meaningfully different amounts to run, yes. A CNC machine carrying lease, tooling and power should not recover overhead at the same rate as a hand welding bay. A single blended rate is fine when the mix is consistent, and it quietly cross-subsidises once one work centre becomes busier than the others.
- Does the owner's salary go in overhead?
- It depends on what the owner does. Hours spent turning billable work belong in direct labour. Hours spent quoting, selling and managing belong in overhead. Owners who bill and manage should split their time between the two, because putting the whole salary in either place distorts the rate in a predictable direction.