Flat rate vs. hourly: what's the difference?
Business owners have two options when it comes to getting paid: a flat rate and an hourly rate. Understanding the difference between flat rate vs. hourly is essential if you're self-employed. This guide will help you compare these pricing systems to help you determine which is right for your business.
What is flat-rate pay?
With flat-rate pay, you charge your client a set price for the scope of work you complete. This price is basically a flat fee that doesn't change with the number of hours you put into the project. In some cases, the flat rate may be based on the amount of time you expect a project to take, though the final cost remains the same regardless of how much time you actually spend.
For instance, an auto mechanic might charge a flat rate for certain services, such as an oil change or brake inspection. Your flat rate may be based on the expectation that the service will take roughly two hours. If it takes more than two hours to complete the work, the final price remains the same.
How to calculate flat rates
Calculating your flat rate demands that you consider both your time and the materials you might use to finish a particular project.
1. Calculate your time
First, calculate the cost associated with the time you expect to spend on the project. Estimate the number of hours you expect the project to take, then multiply by your hourly rate.
Here's a tip: aim slightly high when you estimate your time. It's better to finish a project early than get behind schedule.
2. Calculate material costs
Next, you'll add together the cost of all materials and other costs that the project demands. Remember to add a small markup percentage so you profit from the project; otherwise, you'll find yourself breaking even.
3. Calculate your grand total
Finally, add your labor and material costs together. This total will form the minimum price you charge for your flat rate. While you can use this final price as your flat rate, you might also charge extra for select services or projects based on perceived value. In other words, if a particular project demands a specialized skill, you might charge more money.
Once you determine the flat rate for each service, you can advertise these flat rates on your company website or other promotional materials.
Advantages of flat-rate pay
The flat-rate pay system offers several advantages, including:
Flat rate systems offer greater predictability for both you and your clients. Your clients will appreciate knowing exactly what to expect upfront, which minimizes the chances of contract disputes or other misunderstandings.
Likewise, small businesses and shop owners can count on predictable income from their flat-rate pricing structure. This approach might also make it easier to plan your budget since you'll be better equipped to predict the amount of work you'll be doing each month.
Workers might be less inclined to put the customer first when paid an hourly wage. But flat rate workers are given incentives to work more efficiently. After all, the more work they do, the more they get paid.
An hourly rate pay system requires you to keep careful records of your time and the time of any employees who work on a particular project. But flat rate work can be done without excess calculations, especially when offering a regular service.
Since you're not charging by the hour, there's no real limit to the amount of money you can make. If you experience a season of above-average productivity, you can tackle additional projects and make even more money than if you'd charged an hourly rate.
Disadvantages of flat-rate pay
At the same time, flat rates can present some unique challenges, such as:
Difficulty in making estimates
Estimates are easy to make if it's a project you've done before or a project with a well-defined scope. Otherwise, you might be scratching your head to develop a set price to offer the customer.
Charging a flat rate can limit your ability to adapt to changing project scope. If you take on a larger project, you may discover that the amount of time and materials is greater than what you'd estimated, but by then, it's too late to ask the client for more money. Flat rates can therefore make it harder to adapt to evolving client expectations.
Decline in quality
If you have employees, you may discover that they rush through jobs to finish more projects and increase their pay. This approach can result in cut corners and your final results falling short of industry standards.
You can't always control flat rates
Depending on your industry, you won't always have control over your estimates. This concern is especially irritating if you're an auto mechanic or body shop owner.
New vehicle warranties add a layer of complexity to your calculation by estimating the time they expect for you to complete a job. If the manufacturer expects the task to be done in one hour and it takes you two, you could end up with less pay when using the flat-rate pay system.
What is an hourly rate?
An hourly pay rate is based on the time it takes you to complete a job. This method requires you to keep track of the number of hours you work, then multiply by your hourly rate. On the one hand, hourly rates demand a bit more attention to detail, but on the other hand, hourly rates give you greater flexibility when working on long-term projects subject to frequent changes.
How to calculate hourly rates
Calculating your hourly fee is very straightforward. Simply multiply your hourly pay rate by the total number of hours you've worked.
Naturally, this demands that you keep an accurate record of your time on a project. Some clients may even ask that you provide a breakdown of your time on your invoice. The legal profession, for example, breaks down its members' time in 10-minute increments.
This breakdown is essential because while flat-rate billing is based on estimates, hourly rates are expected to conform to the actual time invested in a project.
Advantages of an hourly rate
What are the advantages of an hourly billing process?
Charging an hourly fee gives you the greatest ability to adapt. This adaptability can be crucial when working on projects that can change or evolve. That's why the hourly rate pay system has become industry-standard among freelancers working on large or detailed projects.
Easier to compare rates
When clients are looking for a particular service, hourly rates are the easiest ways to compare competing companies. This approach might make it easier for clients to understand your billing process since a set price doesn't always communicate the cost of materials.
Your workers can rely on constant employee income with hourly pay, even when business might be slow. This approach can be an essential way to keep your workforce satisfied, especially in an era where workers are apt to change jobs frequently.
Disadvantages of an hourly rate
Despite these advantages, there are some drawbacks to an hourly billing system. These include:
Hourly rates demand rigorous bookkeeping
For starters, hourly billing methods demand sustained attention to the number of hours you and your employees have worked on a project. Though numerous electronic tools assist with recording time, it can still bring more personal stress than simply charging a flat rate.
Offering your employees an hourly wage can actually discourage productivity. If you're a business owner or shop owner, you may discover that your staff isn't always eager to complete their work. After all, they'll be paid the same wage either way, as long as they're on the clock.
Less opportunity to grow your business
If you exclusively use hourly billing methods, then you're essentially setting a limit to the amount of money you can make. Why? Because if you do the same amount of work each week, your weekly wages will never change.
Additionally, there's no guarantee of a minimum payment, unlike the reliable flat-rate system. Hourly rate pay can limit your ability to take on new projects and expand your small business.
When to choose flat rate vs. hourly
How do you choose when to use flat rate vs. hourly rates? Both flat and hourly rates can be great for self-employed professionals and small business owners, but you should select each billing system with care.
Best reasons to use flat-rate billing
The flat-rate billing method is ideal for:
- Freelancers who complete their work on time
- Companies that offer standardized services
- Projects that have a narrow, predictable focus
- Short-term projects
Additionally, flat rates give you more opportunities to expand and grow your business. As your productivity increases, you'll have more time to take on additional work, resulting in more profits.
Best reasons to use hourly billing
The hourly billing method can make sense for:
- Long-term projects that have frequent changes
- New business owners who lack experience in making project estimates
- Workers completing in-house projects
- Employees with an efficient time tracking system
Some clients may appreciate hourly rates as they offer greater transparency. This billing method can also make it easier for potential clients to compare your rates to your competitors. Additionally, flat rates might represent a high upfront cost, so some clients may find the flat-rate pay system financially prohibitive and opt for an hourly rate.
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Frequently asked questions
Do you still have specific questions regarding flat rate or hourly billing? Here are some of those most commonly asked by today's business owners:
Keep in mind that these two pricing systems are very different, and your invoice should reflect these distinctions. You can create a flat rate invoice as well as an hourly rate invoice. The majority of the invoice will be the same, but the "description" section will reflect the payment system.
Your flat rate invoices will list the services you provide, while your hour rate invoices will record your hourly pay rate and the amount of time you devote to various project stages.
Charging an hourly rate is very different from flat-rate billing. While flat rates are based on the time you expect your work to take, your hourly pay depends on an accurate presentation of the time you've spent.
At the same time, there's no exact rule. Some freelancers prefer using 15-minute increments, though some mirror the legal profession and document their time in 10-minute increments. Just mention your method to your clients beforehand so there are no surprises when they receive your invoice.
How do employees get paid if your business charges your customers a flat rate? In many cases, you pay your workers a base hourly rate but offer additional compensation upon completing a project. This base hourly pay rate can be conditional on completing other tasks, such as cleaning, sorting inventory, etc.
That's why you should ensure that your employee job descriptions include a variety of tasks before you hire workers. This way, you'll have the assistance you need on particular projects and the flexibility during slower seasons.