I’ve had a few people contact me recently asking how I figured out what to charge for consulting work. Once I got started answering, I realized, it’s a pretty in-depth answer, so I figured I’d write it up here in case anyone else is curious. I’d love to hear your thoughts in the comments on how you figured things out.
***Note: This blog post is meant to show you what kinds of things you should take into account. It is not meant to give you exact numbers. The numbers below have purely been made up so that the math works out nicely. You will need to research and come up with your own values for the numbers below.
The way I figured out my hourly rate was to first take a look at how much I needed to make each month and how many hours I was able to (and wanted to) work each week.
Say you want to work 40 hours per week. Of those 40 hours, you’ll need to figure about an hour a day for e-mail and around two hours a week for meetings (perhaps more or less depending on the type of work you get and the type of client you work for. You’ll also want to factor in about three hours a week for time tracking, accounting, invoicing, administrative tasks, etc. So, in a 40-hour work week, you are only billing for 30 of those hours, or 120 hours per month.
Then, you’ll need to factor in that you won’t always be able to fill those 30 hours every week. So knock a week out of each month for new client acquisition and/or slow weeks, which puts you back to 90 billable hours per month (even though you are working 160 hours).
Then, factor in how much “paid” vacation time you’d like to have and make your best guess at how many sick days you use on average. Divide this by 12 and you’ll have the amount of time “per month” to remove from your billable time. Let’s say you want three weeks of vacation and 3 sick days. That’s 1.5 days (or 12 hours) per month, which puts you at 78 billable hours per month.
Now, go back to what you need to earn each month. You’ll need to look at what your state/province/country charges and what your income bracket will be, but remember that you’ll be paying your income taxes, social security, FICA, etc. as well as the business taxes, which include the business portion of social security, FICA, etc. So, it’s basically double your current social security, FICA, etc. and then about one and a half times your current income tax level (though to be safe, it’s always better to estimate 2 times your current income tax). When running your own business in the U.S., you never want to owe the IRS money at the end of the year. You can end up with fines if that happens two years in a row, so it is much better to overestimate and get a refund than risk the fines. For our example here, let’s figure about 20% in taxes.
So, let’s assume that you want to make $5000 per month. You’ll need to bring in approximately $6250 before taxes. In addition, you’ll want to save for retirement. In the U.S., you can put about 15% into a SEP IRA (the consultant’s equivalent of a 401K). So then you’ll need to make approximately $7353 (the SEP payment is pre-tax, which is why I am adding it after we calculated taxes on the amount).
Also, consider health insurance and dental. Some people can get this through the government or a spouse, but assuming that you can’t, you’ll need to add in the cost of health and dental insurance. Let’s assume about $400 a month for health insurance and $50 a month for dental (which is also pre-tax). That brings you to $7803, which we’ll round to $7800 to make the math cleaner.
Putting this all together, you need to make $7800 per month working 78 billable hours per month, so you’ll need to charge $100 per hour.
There are a lot of other factors that could also go into this number. For instance, your state/province/country may require business fees, filing fees, etc. Perhaps you will want to have an accountant handle some of your finances or your tax preparation. Perhaps you now need a financial management company to handle your retirement funds. Maybe you participate in a health savings plan where you will be using more money pre-tax. Perhaps you want to contribute to more than one retirement plan. Perhaps you have additional health care costs, like monthly medications. Perhaps you have daycare, a mortgage, a car payment, or student loans to factor in. Also keep in mind that it’s a good idea to set some money aside for savings, for emergencies, for future vacations, for a new phone, etc. You will need to evaluate your monthly expenses and see what your budget requires.
Once you’ve figured out your hourly rate, take a look at what other contractors in your area are charging along with what other contractors in your industry are charging. Because we can work remotely, it’s important to look industry-wide, not just in your geographic area. See if your hourly rate is comparable to what others are charging. You want to be competitive but make sure you do not undersell yourself.