Setting Up a Welding Shop by the Numbers
Chapter 8 of 10 · 10 min read
What an hour costs
Build a small shop's yearly costs from wages and overhead, divide by the hours it can bill, add a margin, and see how the rate depends on utilisation and on the owner paying themselves.
The commonest way for a small welding business to fail is to be busy and lose money. The owner works long hours, the jobs keep coming, customers are happy with the prices, and at the end of the year there is nothing left, or less than nothing, because the hourly rate never covered the business’s costs. The early writers saw it happen. Willis wrote in 1917 that few custom welding shops properly took into account their overhead expense, which he listed as rent, telephones, advertising, postage, bad accounts, depreciation of equipment and the failure of welds, and that unless at least 100% was added to the actual labour, gas and material cost to cover it, the business would not go ahead. The Imperial handbook told its readers to allow a fairly high percentage for overhead in a repair shop.
This chapter builds Mara’s shop’s yearly costs, divides them by the hours the shop can actually bill, adds a margin for profit and risk, and shows how strongly the result depends on two numbers new owners often get wrong: their utilisation and their own wage.
Pay the owner first
Willis made a point that many owners still miss: if the owner of the shop does their own welding, they should charge it at the same price they would have to pay an employed welder. An owner who leaves their own wage out of the costs is not making a profit when the business shows a surplus; they are being paid, perhaps poorly, for their work. Mara included her own pay at the wage she would have earned as a leading hand, plus superannuation, as a cost of the business before any profit. Whatever she actually drew from the business each month, the cost of her time went into the rate, so that the shop would still be viable if she later employed someone to do the welding she now did herself, as she hoped to.
The yearly costs
| A$ a year | Notes | |
|---|---|---|
| Sam's wages with on-costs | 83,980 | about A$34 an hour plus about 25% on-costs, 1,976 paid hours |
| Mara's pay with superannuation | 100,800 | at a leading hand's rate |
| Rent and outgoings | 34,000 | 240 m² industrial unit |
| Depreciation of equipment | 10,860 | Chapter 6 |
| Vehicle | 9,000 | site ute running costs charged to the business |
| Insurance | 6,500 | public liability, equipment, workers' compensation |
| Electricity | 4,300 | energy and supply charges, Chapter 3 |
| Interest on the loan | 4,000 | equipment and set-up, Chapter 6 |
| Accounting and legal | 4,000 | bookkeeping, tax, advice |
| Bad debts and warranty allowance | 5,000 | unpaid invoices and rework |
| Advertising, phone, software, bank | 5,500 | together |
| Maintenance, training, safety, shop consumables | 5,000 | together |
| Gas cylinder rental | 960 | Chapter 4 |
| Total | about 273,900 | wages about 184,800 and overhead about 89,100 |
The overhead, everything except the two people’s pay, is about A$89,000 a year, about 48% of the wages. Willis’s rule of adding at least 100% to labour, gas and materials was a rough rule for a different time, but it points the same way: a shop’s overhead is a large fraction of its labour cost, and prices that cover only labour and materials lose money.
Dividing by the hours that can be billed
The yearly cost must be recovered from the hours the shop can charge to customers, not the hours it is open. Chapter 1 estimated those at about 2,340 billable hours a year.
- Wages and overhead
- about A$273,900 a year
- Billable hours
- about 2,340 a year
- Margin
- 12%
- cost per billable hour ≈ 273,900 ÷ 2,340 ≈ A$117
- rate ≈ 117 × 1.12 ≈ A$131 an hour
- rounded to a shop rate of about A$130 an hour, excluding GST
A shop rate of about A$130 an hour for a welder’s time surprised Sam, who had been paid about A$34. But the A$34 is less than a third of what each billable hour costs the business, once the unbillable hours, the owner’s pay, the rent, the equipment, the insurance and everything else are counted.
Utilisation decides the rate
The billable hours depend on utilisation, the fraction of working time charged to customers, and the rate is very sensitive to it.
If the shop bills 2,000 hours instead of 2,340, perhaps because Mara spends more time on quoting and administration than she expected, or the work is slower to arrive, the rate needed rises to about A$153. If it bills 2,600, the rate needed falls to about A$118. A shop that sets its rate assuming high utilisation and then achieves a lower one loses money on every hour, which is why Chapter 10 tracks utilisation from the first month.
The break-even hours
The same numbers give the hours the shop must bill just to cover its costs, with no margin. At a rate of A$130 an hour, the shop covers its yearly costs of about A$273,900 once it has billed about 273,900 ÷ 130 ≈ 2,110 hours. Every billable hour beyond that earns the margin; every hour short of it is a loss. The break-even figure is a sobering one for a new owner: it is about 90% of the expected 2,340 billable hours, which means that a shortfall of a little over 10% in the first year’s work would wipe out the whole margin. It is the reason for the cash reserve in Chapter 10 and for watching utilisation from the first month, and it is a reason not to cut the rate to win work while the shop is still finding its customers.
Labour-only thinking
Many small shops set their rate by adding a margin to the wage, perhaps doubling it. On Mara’s figures, Willis’s rule applied to labour alone gives about twice the cost of the people’s time per billable hour, A$79 × 2 ≈ A$158, which happens to be above the cost-based rate here, because her overhead is moderate. For a shop with high rent or expensive equipment, doubling the wage may fall short. The only reliable method is to count the actual costs and divide by the actual billable hours.
What the market will pay
The cost-based rate is the minimum the shop needs, not necessarily what it charges. If competitors charge less, the shop must find ways to reduce its costs, raise its utilisation, or offer something worth paying more for, such as speed, quality, availability or site service. If competitors charge more, the shop may be underpricing its work. Mara asked around and found that local shops charged between about A$110 and A$140 an hour for welding, excluding GST, with higher rates for site work and urgent call-outs. Her A$130 was within the range, and she set a site rate of A$145 to cover the vehicle, travel time and the welder-generator. She did not undercut the cheapest shops to win work, because her costs, not theirs, decided what she could afford to charge, and a price war with established businesses is one a new shop is unlikely to win.
Different rates for different work
One rate for everything is simple, but it may not fit the costs. Site work uses the vehicle and generator, involves travel and is less efficient; shop fabrication uses the floor, saw, table and hoist; repairs at the bench use little floor but take more of Mara’s time to diagnose and quote. Some shops charge different rates for shop work, site work and machining, or a premium for urgent and after-hours work. Mara started with a shop rate and a site rate, plus a call-out charge for site visits, and planned to look at the job records after six months to see whether any work was being carried by the rest.
Overhead absorbed by materials
Some overhead can be recovered through materials rather than hours. The shop buys steel, consumables and parts for jobs, stores them, handles them and carries the risk of waste and price rises, and a markup on materials covers those costs. If the materials markup recovers some of the overhead, the hourly rate can be correspondingly lower. Chapter 9 sets the markup and shows how the two together recover the shop’s costs on a job.
What on-costs are
An employee costs more than their hourly wage. On top of the wage, the business pays superannuation, workers’ compensation insurance, and the wages for annual leave, public holidays and sick leave, which are paid hours that cannot be billed. Depending on the business’s size and state, it may also pay payroll tax, and it pays for protective clothing, training and the time spent on inductions and toolbox talks. Mara’s accountant suggested allowing about 25% on top of Sam’s base wage for on-costs, which is included in the A$83,980 above, and checked the figure against the award and her insurer’s premium. Leaving out on-costs is one of the most common reasons a new shop’s rate comes out too low.
Where the unbillable hours go
Chapter 1 estimated that of the two people’s 3,600 working hours a year, about 2,340 could be billed, leaving about 1,260 unbillable. Mara listed where she expected them to go, as an illustration: about 300 hours of quoting, estimating and visiting customers; about 250 hours of ordering, invoicing, payroll and bookkeeping; about 200 hours of cleaning, housekeeping and the end-of-day checks; about 150 hours of collecting and delivering steel and jobs; about 100 hours of maintenance and repairs to equipment; about 100 hours of rework that could not be charged; and the rest in training, waiting for materials, and the slack between jobs. Each item is necessary, and each is a target: an hour saved on any of them becomes an hour that can be billed, or an evening at home.
Profit is not optional
The margin in the rate is not greed. It pays for the months when the work is slow, the job that goes wrong, the customer who never pays, the machine that fails out of warranty, and the money needed to buy the next piece of equipment without borrowing. It also rewards the owner for the risk of having put savings into the business. A shop that prices at cost has nothing for any of those, and the first bad month puts it in debt. Mara’s 12% margin, about A$33,000 a year at full billable hours, was modest; her accountant suggested reviewing it after the first year, once the real figures were known.
Rates and GST
Mara’s business is registered for GST, so it adds GST to its invoices and claims back the GST on its own purchases. All the costs and rates in this book exclude GST. Businesses usually quote each other prices excluding GST, but private customers such as farmers buying for themselves may expect a price including it, and quoting a price without saying which can cause a dispute when the invoice arrives 10% higher. Mara’s quotes and job cards state clearly whether each price includes or excludes GST.
Checking the rate each quarter
The rate is set from estimates, and the estimates will be wrong in some way. Each quarter, Mara compares the actual costs with the budget, the actual billable hours with the estimate, and the actual income per billable hour with the rate. If the costs are higher or the billable hours lower than planned, the rate is reviewed. Small, regular adjustments are easier for customers to accept than a large rise after a bad year, and the quarterly check also shows whether some kinds of work are more profitable than others, which Chapter 1 said would decide whether the shop specialised.
A failure: the rate from the old job
This is an illustration. A welder Mara knew had set up on his own a few years earlier and charged A$75 an hour, because that was about double his old wage and it seemed a lot to him. He was busy from the first month, working long hours, and at the end of his first year his accountant showed him that, after rent, equipment, the vehicle, insurance and his own modest drawings, the business had lost money, and he had been working for less than his old wage.
He had made two mistakes: leaving his own wage out of the costs, and assuming every hour he worked could be billed. When he recalculated with the method in this chapter, his rate came out at about A$120. He raised his prices in two steps over six months, lost a few price-sensitive customers, and found that his remaining work paid.
Exercise: a cheaper unit
Mara is offered a smaller, older unit at A$22,000 a year in rent and outgoings instead of A$34,000. If everything else stays the same, what would the shop rate need to be at 2,340 billable hours and a 12% margin? What might the smaller unit cost in other ways?
The yearly costs fall by 34,000 − 22,000 = A$12,000, to about A$261,900. The cost per billable hour is about 261,900 ÷ 2,340 ≈ A$112, and the rate about 112 × 1.12 ≈ A$125 an hour, about A$6 less.
The smaller unit might cost more in other ways: less room for the trailer bay (Chapter 2), slower work from a cramped layout, a supply too small for the welders (Chapter 3), no room for a cylinder store outside (Chapter 4), and perhaps fewer billable hours as a result. If cramped working cut the billable hours by 100 a year, the rate needed would rise back to about A$130. The cheaper rent is worth having only if it does not cost the shop its efficiency.
