How to Calculate Cost Rates

Cost rates are specific expenses as they relate to another measurement. For example, how much does an employee cost per hour? Another cost rate formula example might be your food cost per ticket in a restaurant. If you decide to open a small business, become a consultant or move into some other type of entrepreneurial venture, it will be important to know how to calculate different cost rates.

Reviewing how to calculate cost price and rate will help you make sure you set your prices to cover all of your expenses and provide you with the profit you need to make your venture worthwhile.

Costs are any expense of doing business. They include anything for which you are billed or have to pay. For example, if you pay yourself a salary, that’s a cost to the business. If you take profits out of your business at the end of the year, that’s typically not considered a business expense or cost, at least in terms of budget or pricing planning.

Businesses set their prices and track their performance by breaking down their expenses into different categories. Examples include labor, materials, manufacturing overhead, selling and general/administrative expenses.

Some costs are classified as fixed, while others are variable. Creating these categories helps businesses keep an eye on expenses by applying calculations, such as a cost price formula, to see if they can better control them.

For example, your overhead costs are those that you’ll have even when you don’t sell a single unit of product or bill a single consulting hour, explains the Corporate Finance Institute. Overhead expenses include costs like marketing, insurance, rent, phones and internet. Manufacturing costs include your materials, labor and any other expenses to make your product.

Many restaurants set a target percentage food cost per ticket to ensure they can make a profit, according to Budget Branders. For example, a cheap breakfast restaurant might target 18 to 20 percent food costs, a casual dining restaurant might target 25 percent, and a steak and seafood restaurant might be able to handle 35 to 40 percent food costs.

This means that if the casual dining restaurant charges ​$10​ for its hamburger and fries, it can only put ​$2.50​ worth of food on the plate. The rest of the money must cover overhead and profit.

Let’s say the business wants to serve a new Tex-Mex special that costs ​$3.00​ to make. It needs ​$3.00​ to cover 25 percent of the selling price. So, the company would divide 3 by .25 to get 12, or a ​$12​ sale cost. A breakfast restaurant with a target 18 percent food cost would sell an omelet with ham and toast that costs ​$1.10​ to make for a sale price of ​$6.11​ (1.10/.18).

Companies that want to know their true labor costs must calculate the cost rate not only by the employee’s salary or wages but also by the employee's benefits, payroll taxes, office square footage (rent), computer hardware, software licenses, workers’ compensation insurance and all other costs related to having that employee.

The company would then divide that annual number by the number of hours the employee works. If the employee’s contract requires her to work 40 hours per week with two weeks of paid vacation, the company would divide her cost by 2,080 hours to get her hourly cost rate.

Knowing cost per hour helps when an employee serves different departments. For example, if a graphic designer for a nonprofit works five hours per week on the organization’s website, 10 hours on the monthly magazine, 10 hours for the meetings department and 15 hours for the fundraising department, the nonprofit can get a better idea of each of those department’s expenses.

If her salary is ​$50,000​ but her overhead costs are another ​$7,500​ in taxes and other expenses, the company would calculate her hourly cost rate by dividing $57,500/2,080 to get an hourly cost rate of ​$27.64​. Her 10 hours of work per week for the meetings department will cost that department ​$276.40​ per week, or roughly ​$14,373​ per year.