Intra- and Inter-company billing is common for shared services like IT, HR, and Accounting. If your billing and allocation rates are based on 2,080 hours, you are missing the mark by nearly 37%. In this post I will explain why that is, what the correct benchmark should be, and show a comparison of billing rates pre- and post-adjustment.
WHO SHOULD CARE, AND WHY
Stakeholders in internal (and external) billing rates range from entry-level staff to shareholders. Your level of interest is likely tied directly to your personal financial interests. For the best long-term results, consider all stakeholders and think “win-win.”
Shareholders and Senior Management: Without proper oversight, staff positions will grow bloated and suck both time and money. The first line of defense against that giant sucking sound (not to be confused with Ross Perot’s prediction about NAFTA) is a thorough understanding of the actual costs of administrative and support activities. Whether you own the company or are accountable to the shareholders, creating value is the first priority – and that means cost control as well.
Shared Service Staff: If you do not understand the true value you bring to the organization, you should be very nervous. How else will you know whether you are wasting time in unproductive pursuits? Conversely, how can you demonstrate the economic value you deliver to the company? You are your only true advocate, and there are times when the dollar value of your work might not appear on the financials. You need to be able to establish your value proposition to the company based on relevant data.
Shared Service Team Managers: You are the bridge. Your job is both to bring value to shareholders through cost containment and understanding; and to demonstrate your team’s value as a basis for appropriate employee pay, incentives, and resizing. Fail in the first task, and you will be replaced. Fail in the second, and suffer poor morale.
THREE INPUTS TO INTER-COMPANY RATES
The calculation process is straightforward but requires some pencil pushing. You will need three source numbers:
- Annual employee cost. Pay, taxes, and benefits – actual, or estimated. This is the easy part.
- Billable hours benchmark. An accounting of expected available labor hours. It may not be what you expect, and errors here might push rates off by 40%.
- Time tracking data. The actual hours and minutes to bill, for what, to whom.
With this information in hand, the formula for at-cost billing will be ((Billable Benchmark)/(Annual Cost))*(Time Used).
Let’s get down to business.
1: ANNUAL EMPLOYEE COST
Source data: The simplest form of this is salary plus taxes plus benefits. You will likely have to settle for an approximation of the latter two since tax costs are affected by limits and benefits by participation. If the services you are splitting out are also charged overhead, include those costs as well.
My estimate for T&B has always been 20%, though my P&L often indicated closer to 17%. The ratio is most accurate if you use a recent full-year figure since payroll taxes are highest in the first part of the calendar year.
I have seen businesses mark up salary by 50% to cover T&B and overhead in one fell swoop. I have found that number harder to validate. In the end: if you have an accurate number for all costs associated with any person, function, or department – use it as the employee cost.
Alternative data sources: If you have no access to real numbers or are projecting proposed costs, one good data source is O*NET Online – an occupational information site developed by the US DOL. The site is free and houses extensive data for hundreds of job titles. For example: according to O*NET, the median U.S. wage for Bookkeeping, Accounting, and Auditing Clerks in 2016 was $18.46 per hour or $38,390 per year. The site also breaks those figures down by state.
2: BILLABLE HOURS BENCHMARK
There are 2,080 “work hours” in a year for a typical 40-hour-per-week, full-time job. The norm for professionals is usually higher. My estimate of the average professional work-week is around 50 hours, despite horror stories of lawyers and accountants piling up 100 hours each week. (After writing this, I looked it up. According to a 2014 Gallup poll, U.S. professionals average 49 hours per week. Wow. I’m good.)
Despite people working more than 40 hours per week, you should use *fewer* than 2,080 hours when calculating intra- and inter-company billing rates and employee costs. There are two good reasons:
- You need to fund all the unbillable hours your team consumes. This includes holidays, training time, and so forth.
- All hours over or under the benchmark represent a surplus or shortfall of economic value the team is delivering, and of demand for their services. This translates directly to incentive and head count decisions.
Any intra- or inter-company cost centers benefitting from the work your team does should help pay for unbillable hours. If not, the team is going to look like an oversized cost-center on the parent company P&L, and someone likely will make painfully wrong decisions based on incorrect information.
So 2,080 isn’t the right annual hour benchmark. What is? To get the right number, you must first adjust for Paid Time Off (PTO), and administrative overhead time.
Adjusting for PTO
Paid Time Off comes in many varieties. Here, I am going to stick to just the basics: vacation, sick leave, and holidays (two types). “BLS” below refers to the U.S. Bureau of Labor Statistics website.
Vacation. While vacation time is not required by law for U.S. companies, it is part of U.S. culture and a vital inducement for hiring and retention. The BLS average for vacation leave for office staff professionals is 84 hours. We’ll round down to 80 hours, or two weeks’ vacation.
Sick Leave. If your company does not break sick leave out from other PTO, it may have to change in the future. There are now at least ten states requiring businesses to provide sick leave in proportion to hours worked. The most generous law requires eight ‘sick days’ per year for a full-time position, but most laws cap it at five. Some states (Arizona, for one) also prohibit sick leave from expiring. We’ll use five days (40 hours) for this exercise.
Paid Holidays. I am allowing for two types of Holidays; national, and personal.
National Holidays: U.S. Federal Employees get ten paid Holidays, which is surprisingly close to the national average for professionals. In fact, the average professional gets 85 hours; about a half-day more than Federal Employees. We’ll stick with 10 days / 80 hours for this example.
Personal Holidays: Alternatively called “personal leave” or “personal holidays”, the national average for professionals is 50 hours or just over six days. Frankly, I’m shocked. Apparently, I have been working in a bubble for 30 years. Nevertheless, it seems reasonable to assume 50 hours.
TOTAL PTO ADJUSTMENT: 250 HOURS PER YEAR. Note that these are *available* hours, and not always taken. Still, when calculating costs you should be conservative and assume the worst. 250 hours it is. We now have 1,830 billable hours – but we aren’t done adjusting yet.
Adjusting for Administrative Overhead
Every employee in every position has at least some unbillable, unproductive time. There are short and long ways for tallying those hours. The method you use depends entirely on how much you must justify your calculations or the level of precision you demand. (Whether now or later, I strongly recommend doing the long way – you’ll learn a lot.)
The Short Way. You could estimate this part with a Pareto-style assumption of 20% overhead, which my experience confirms to be fairly accurate. If you must justify your calculations, then there are no shortcuts. Fair warning before you run the gauntlet: doing this the long way might take a week or more.
I will say this: people are horrible at estimating time. Want proof? Have an impromptu meeting with a subordinate, and time it without their knowledge (or a nearby clock). After ten or fifteen minutes, ask them how long they think you’ve been talking. One of my programmers was off by more than 50%.
The Long Way. Getting a more accurate number requires time tracking, which I cover in-depth in a separate post. Short version: you must collect and analyze real data on work hours to know how much unproductive (unbillable, but probably unavoidable) time you lose each week. Unbillable time includes training, coffee breaks, rebooting computers, processing spam, and a hundred other activities.
TOTAL ADMIN OVERHEAD: My team went the long way for several months and found that the average was about 17% of non-PTO hours. Based on our running total of 1,830 non-PTO hours, that works out to a sobering 311 hours per year of unbillable overhead time. The Pareto approach would have estimated overhead at 366 hours.
2a: ADJUSTED BILLABLE HOURS BENCHMARK: 1,519.
We lost 250 hours to PTO and another 311 to administrative overhead, leaving 1,519 expected billable hours per person per year. That 561-hour reduction is 27% of the standard 2,080-hour benchmark. An example below shows how that 27% reduction in billable hours translates into a 37% change in total billing.
3: TIME TRACKING DATA
Finally, you will need a count of hours to bill to other companies or departments. Again, time tracking is the best answer here. Target 15-minute increments, rounding down at 7 minutes, up at 8. You may end up with more billed hours than there are hours in the day. Keep people focused on working in chunks/buckets of similar duties or for a single company to minimize inflation.
You may want to check out this Time Tracking Template spreadsheet or read more about the specifics of the time tracking process in my post on The Essential Metric of Accounting.
EXAMPLE COMPARISON OF RATES
The table below compares rates using the standard 2,080 hours or my adjusted 1,519 hours for a typical $40,000-per-year clerk.
The numbers are counter-intuitive. A 27% decrease in base hours leads to an outsized 37% increase in the at-cost billing rate. Those ratios stay the same even if you zero out taxes, benefits, and overhead.
| Hours | 2,080 | 1,519 |
| Difference in Base Hours | -27.0% | |
| Salary | $ 40,000 | $ 40,000 |
| Tax & Ben @ 20% | $ 8,000 | $ 8,000 |
| Overhead @ 30% | $ 12,000 | $ 12,000 |
| Annual EE Cost | $ 60,000 | $ 60,000 |
| Cost/Hour | $ 28.85 | $ 39.50 |
| Difference in Billing Rate | +36.9% |
WHY DOES IT MATTER?
For owners of multiple businesses, this may not seem to matter at all. I once showed a business owner how the accounting department of one of their companies (“A”) was billing another of their companies (“B”) $6,000 each year for $20,000 worth of their time, using calculations as above without overhead. Their response? A shrug of the shoulders. The owner wanted Company A (a cash cow) to absorb some costs of Company B. To them, it was like taking a dollar from one hand and putting it in another. (For those wondering about federal tax implications: both A & B were single-owner “S” corporations – the expense would net to zero on their taxes.)
For staffers and their managers, this matters a great deal when it comes to reflecting the value they bring to their organization. In my example above, the accounting team provided $20,000 worth of value to Company B at a cost of only $6,000. Where did the $14,000 go? It was never recorded as a separate transaction, and never reflected on an invoice. Company A absorbed the cost. Without recorded evidence, will anyone know that A saved B $14,000 when they look at the financials? No! The story the P&L’s will tell is the only real story, and that story is “Company A has a really expensive accounting department!”
In the end, accurate [and recorded!] inter-company billing *does* matter to owners – because they need hard and accurate numbers by which to evaluate their companies, departments, and people comparatively over time. The best companies and the best leaders reward their people for contributing to their success, and that builds loyalty, performance, and reputation.
BLS data available at this link. I used the data from the “Management, professional, and related” and the “Sales and Office” sections.