Guide

Hourly rate vs. flat-rate billing: Which is better for you? A guide for small businesses

Understand flat-rate and hourly rate billing, when each works best, and how to decide which to use.

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As a small business owner, you may struggle to decide whether to use flat-rate billing or hourly billing. Traditionally, many small businesses charge for their services by the hour. A more modern billing option is flat-rate billing, where businesses charge a single fixed rate for their services,

Each pricing strategy has its advantages and disadvantages. Some situations – depending on project scope, industry standards, and client preferences – are better suited to one or the other,

What is hourly billing?

Hourly billing is a pricing strategy in which you charge your clients based on the number of hours you spend on a specific task, project, or service. You set an hourly rate for your work. When you charge your clients, you calculate the total cost by multiplying the hours of work by your hourly rate.

For example, if you charge $50 an hour and work on a project for 10 hours, you would charge your client $500.

To implement hourly billing, you need to:

  • Determine your hourly rate: This is often based on market research, your experience and skill set, your overhead costs, and your desired profit margins.
  • Implement time tracking: You can keep track of the time you spend on a job or project using time-tracking software or tools to record the hours.
  • Set expectations: Make sure clients understand your hourly rate. They may want an estimate of how long a project will take before beginning. In this case, make sure you have all relevant information about the project so you can give an estimate.
  • Bill your clients: Regularly bill clients based on your tracked hours, either when specified milestones are reached, at specific intervals such as weekly or monthly, or at the end of a project.

Hourly billing is useful in situations where the scope of the project is unclear or likely to change, or if a project is ongoing.

What type of businesses charge an hourly rate?

Many service providers charge an hourly rate for their services. That hourly rate is based on the level of experience, overhead costs, labor costs, desired profit margin, and project complexity. More experienced service providers typically charge a higher hourly rate.

Examples of hourly rate pricing include the following:

  • A lawyer might charge $300 an hour to provide services to business clients.
  • A graphic designer who works as a freelancer might charge $65 an hour to design a website for a client.
  • A therapist might charge $150 an hour for a counseling session.
  • An accountant might charge $200 an hour for consulting services.

Advantages of hourly billing

One of the advantages of hourly billing, especially for small businesses, is that if you work on projects that often wind up taking longer than expected, you’ll get paid for the extra time you work. This reduces the risk of you accidentally undercharging for a project.

It’s also relatively easy to calculate and explain to your client. If you use invoicing or time-tracking software, the amount of calculating you have to do is minimal.

Hourly billing is transparent. Your client can see the number of hours you’ve worked and how you arrived at the total cost you did. Because hourly billing is easy to understand, your clients can more easily compare your prices with other businesses. Your hourly rate acts as a baseline.

Regular hourly billing enables consistent cash flow. You know you’ll have money coming in at set intervals, which makes it easier for you to plan your expenses and manage your small business finances.

Another benefit of hourly billing is that it’s flexible and adaptable. It works well for long projects or those where the scope changes.

Hourly billing might be right for your small business if you work on longer projects that are likely to change in scope or are less structured. Because clients are billed for actual hours worked, hourly billing allows for changes in project scope or length. Each time more work is added, you charge more based on the number of hours you’ve worked.

Disadvantages of hourly billing

One of the difficulties of using hourly billing is if the length of the project is unknown, clients might be concerned about not knowing the final cost upfront.

It can also be difficult to know what counts in your billable hours unless you have clearly defined the agreed-on tasks. For example, does time spent commuting to and from a job site count as a billable hour? Time spent answering client questions on the phone or by email may also be included, but that must be made clear to the client.

Another drawback is that you aren’t paid for the value of the project. While your work might create a great deal of revenue for the client, or save them a lot of money, you’re paid for the hours you work, not the result the client obtains.

Also, you are trading your time for money – if you finish your project quickly because you work efficiently, there’s no reward.

And having a conversation about raising prices because you've up-skilled or become more efficient can be difficult.

Finally, there’s no guarantee of a minimum payment or a set number of hours the client requires. This can cause unpredictable income, difficulty forecasting income, and missed opportunities.

What is flat-rate billing?

Flat-rate billing is often referred to as project-based or fixed-price billing. In this pricing strategy, you charge a specified fee for a specific job or project. Once quoted, this flat fee doesn’t change, regardless of the amount of time or resources it takes for you to complete it.

When implementing flat-rate billing, you need a clear, agreed-upon set of deliverables and scope of work. You’ll use this information along with estimated time to complete the project, your expenses, and your overhead to quote a fixed price.

Many small businesses, such as electricians, plumbers, and graphic designers, use flat-rate billing. Customers like it because they know exactly how much the project will cost upfront. They don’t have to worry about additional costs or the project taking longer to complete.

If you use flat-rate billing, you need to know how long projects will take. You can calculate this based on average times in your industry combined with your experience. It’s essential that, as a contractor or small business, you define projects well (and preferably in writing) so you and your clients are clear on what work is and isn’t included in the price.

What type of businesses charge via a flat rate?

Service providers often charge a flat rate for a service. They often have a pricing structure for different projects, each of which is at a fixed rate. The more complicated the project (and the more materials involved), the more likely the flat rate will be higher.

Some examples of flat rate pricing include the following:

  • An electrician might charge a fixed rate of $250 to install a new electrical outlet.
  • A shipping company might charge a flat-rate shipping fee of $50 to ship a parcel.
  • A house painter may charge a specific rate per house, based on the size of the house, the amount of work involved, and the cost of the materials. A smaller house may cost $1,800 to paint, while a larger house might cost $2,500 to paint.
  • A bookkeeper may charge a flat rate of $500 monthly, depending on how complicated the books are.

Advantages of flat-rate billing

Flat-rate billing is simple for clients to understand. They appreciate knowing the full cost, which helps them budget. It’s also transparent because clients can see exactly what’s included in the scope of the project.

It saves you time as a small business owner because you don’t need to review time sheets and make frequent billing decisions in order to get paid. .

Although you need an estimate of how long a project will take, you aren’t penalized for being efficient at your job. If the job takes less time to complete, you still get paid the same amount. This makes your income more predictable.

Because the flat rate is based on the set scope of a project, it’s less likely that the work will change mid-project.

If your business provides standardized services, flat rates can be easy to implement and communicate. Projects that have a clear and well-defined scope that can easily be outlined are ideal for flat-rate billing. Short-term projects are suited to flat-rate billing because they are less likely to experience scope changes or delays.

Disadvantages of flat-rate billing

A disadvantage of using a flat-rate system is the risk of underquoting a project, especially if you’re a less experienced business owner. If the project is more time-consuming or complex than you expected, you might end up earning less than you should.

While you might be concerned about undercharging, clients might be concerned about overpaying. They might be hesitant about flat-rate billing or will even refuse it if they don’t feel they have a clear breakdown of costs. Clients might also hesitate about the price if it is for an expensive job, especially if they must pay an upfront fee.

It’s important to fully explain and agree on the scope of the project and all deliverables, and agree on how any additions to the scope will be handled. If you’re a creative freelancer or contractor, a portfolio of past jobs may show clients your value, which makes the pricing discussion easier.

Combining hourly and flat-rate billing

Some freelancers and contractors use a combination of hourly rate and flat-rate billing where the time that the job will take is somewhat unclear but the client needs certainty for their budgeting. The contractor works on an hourly rate, but also provides an estimate of the expected time and cost, and agrees on a fixed upper limit. This way, the risks are shared between the contractor and the client.

As an example, a technical writer who expects to complete a user guide in 30 hours might allow another 10 hours as a contingency in case it takes longer than they expect to gather the information or they need to do extra work due to client review feedback. They might charge $100 an hour to develop the user guide, estimate that it will take 30 to 40 hours, and agree to charge no more than $4000.

FAQs

Which is better for small businesses: flat-rate charge or hourly billing?

The pricing model you use depends on a number of factors. These include the type of business, industry standards, client expectations, and the specific projects you work on.

What questions should you ask yourself when deciding whether to charge a flat rate or an hourly one?

Some questions you should ask yourself:

  • Is the project well-defined with a clear scope? If yes, this suggests flat-rate pricing.
  • How predictable is the duration? If it is highly predictable, use flat-rate pricing. If not, hourly pricing.
  • Is there an industry standard or expectation? Use that pricing strategy.
  • How comfortable are you estimating costs and timelines? If you’re not comfortable, use hourly pricing.

Is flat-rate pricing more expensive than hourly billing?

This depends on several factors, such as the nature of the project, how efficient you are at your work, and the scope of the work. Flat-rate pricing encourages efficiency because the faster you complete the task, the higher your hourly rate is.

Disclaimer

Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.

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