Choosing the right pay rate is a critical step for any independent contracting professional. If you choose a rate that is too low, you won’t be able to support yourself. If you choose a rate that is too high, you may scare off potential clients and limit your earning potential.
Figuring out how much to bid for a project can be extremely stressful for those individuals who are new to freelancing and consulting. Although there is no such thing as a one size fits all solution, the following framework should help you calculate a fair (and ideally profitable) freelance quote.
STEP 1: BILLABLE HOURS
The first step is to figure out how many billable hours you’ll have each week. Billable hours are a unit of time in which an individual has worked on a task that pertains directly to a client’s project and can thus be expensed to that client. In other words, more billable hours means more opportunity to earn income.
A common mistake that many freelancers and consultants make is that they overestimate their number of billable hours. For instance, a lot of people assume that because there are 52 weeks in a year and 40 hours in a work week (give or take), this means they will have 2,080 billable hours annually, ( i.e. 52 weeks x 40 hours). 2,080 is a good starting point, but it isn’t the complete story.
As opposed to most salaried positions, freelancers don’t receive paid time off. This means that you won’t be compensated if want/need to take a vacation, or get sick or want to celebrate a holiday. When calculating your number of available billable hours, You should try to roughly estimate how many days off you’ll want to take in a year and subtract that amount from the number of weeks you’re planning on working.
Another reason why freelance consultants underestimate their billable hours is because they don’t realize how much time they will have to spend performing non-billable tasks. In a large company, you have specialized departments that focus on specific tasks that are critical to that business’ success, i.e. marketing, legal, finance, etc. As a freelancer, you’re going to have to complete a lot of these administrative tasks yourself. I’d estimate that ~20% of your time will be spent performing run the business tasks.
When calculating your billable hours, it’s also probably a good idea to take into account the fact that you most likely will not always be working at full capacity. There are bound to be periods where you’re either between clients or you won’t have a full roster. It might be a good idea to add a little padding into your billable hours numbers in order to account for this.
STEP 2: OPERATING COSTS?
The next step in the process is to figure out the minimum amount of money you would need to sustain your current lifestyle and to cover the cost of running a freelancing/consulting business. When compiling your list of expenses you way want to consider the following:
- Personal Expenses – Housing (apartment rent, monthly mortgage payments), Utilities, Food, Clothing, Car Payments, Parking, Tuition.
- Office Expenses – Office Rent, Supplies (pens, paper, toner, etc), Equipment (computers, phones, printers, etc),Business Subscriptions: (Dropbox, Harvest, Freshbooks, etc.)
- Marketing Costs – Business Cards, Website Hosting, Advertising.
- Professional Costs – Licenses, Professional Organization Dues, Conference fees.
- Travel – Cost to visit clients
- Insurance – Health Insurance, Liability Insurance, etc.
STEP 3: TAXES
When you are a salaried employee, your employer automatically takes money out of your paycheck for taxes. When you are a self-employed worker, you’re responsible for these taxes yourself and will need to account for this in your quote. After you’ve determine your operating costs, you should consult the IRS’ Estimated Taxes table to figure out approximately how much your tax contribution will be.
STEP 4: MINIMUM ACCEPTABLE PAY RATE
Your minimum pay rate is the lowest amount of money you can charge while still being able to pay all of your bills and taxes. If you don’t want to make major lifestyle changes, your minimum pay rate is the lowest figure you should accept for a job. In order to calculate your minimum pay rate (a.k.a. minimum acceptable rate or return), simply divide your operating costs by your billable hours and add on the estimated tax.
(Operating Costs/Billable Hours) + Tax
WHAT IF I WANT TO DO MORE THAN JUST BREAK EVEN?
The minimum pay rate should be thought of as a starting point. While it’s great to be able to cover all of your bills, you also, most likely, want to earn some sort of profit. This requires asking for a quote that is above your minimum rate.
In the next part of this series, we’ll offer some thoughts on deciding how high to go in your bid and will offer tips for the freelance negotiating process.