Here is how I determined how to set my freelance contract rates. To start with you need to figure out how much you want to make in a given year. Let’s start with $100,000 for a nice round number. Whether or not you can actually make that much depends largely on your market and your technical skillset. Don’t take any of these numbers as specifically applicable to you, they are simply hypothetical.
Before we start, I recommend following along by creating a spreadsheet so you can play around with these figures and come up with a set of numbers that makes sense for your situation.
When I first started freelancing my initial thought was I make X dollars a year as an employee, which equates to Y dollars an hour. So when I start freelancing, I’ll simply charge Y dollars and make the same amount of money. Unfortunately that’s not how the world works.
When setting your rates there are some things to take into account:
- You will almost never be able to bill 100% of your time, especially in the beginning when you don’t have a strong clientele built up.
- You need to plan for healthcare costs
- You need to plan for training and conference expenses
- If you have an office you will need to account for the cost of your office space
- You will need to factor in time for vacation
This list isn’t necessarily complete, but will give us a good starting point.
Now our desired income is $100,000 per year. In a standard work year of 8 hours a day, 5 days a week, there are 2080 hours per year. Our first step is to calculate how many billable hours we will have in a year.
Starting with 2080 hours we subtract the following amounts, change these numbers to what you find suitable in your own spreadsheet.
- 80 hours for holidays (New Years, 4th of July, Thanksgiving, Christmas, etc).
- 80 hours for vacation per year
- 40 hours for sick time
- 40 hours for attending a technical conference
After subtracting all of those hours from 2,080 we come up with 1,840 hours. That is the total number of hours we are available to work in any given year. Unfortunately, you won’t always have contracts lined up back to back, so as a business owner you need to plan for downtime while lining up the next contract. The amount of downtime expected will vary depending on your market and the demand for your particular skillset, however let’s start with 25% downtime. That means in any given year you are planning to bill at least 75% of your available hours to a client. 75% of 1,840 hours equals 1,380.
If those were the only factors we were taking into account, our hypothetical hourly rate would be $72 per hour. ($100,000 / 1380 hours).
The next set of things we need to take into account are business expenses. The following is a list of typical expenses:
- Salary: $100,000
- Employer Fica Match: $10,000
- Office Rent: $1,000 per month for $12,000 per year
- Office DSL/Cable: $150 per month for $1800 per year
- Business Insurance: $50 per month for $600 per year
- Yearly license fees (business license): $500 per year
- Health Insurance: $500 per month for $6,000 per year
- Training budget: $3000 per year
- Book or educational material budget: $100 per month for $1,200 per year
- Computer equipment budget: $2,500 per year
- Office equipment budget: $500
All of those expenses weigh in at a grand total of $138,100. There are more expenses I’m leaving out simply because this is an example. I just wanted to give you a flavor for what types of things you should be looking at.
Now that we have our expense cost of $138,100, we can divide that by our billable hours per year of 1,380. The hourly rate for this particular example comes in right at $100 per hour if you ignore the pennies. Note, it won’t always match up like that, if your desired salary is $50,000 per year the rate would be $60 per hour for our example.
There is one final set of computations I do. It’s not enough to get an hourly rate from someone, you also need to arrange payment terms. I offer a $10 an hour discount to a company that will pay an invoice within 15 days. If they will sign a long term contract guaranteeing a certain number of hours per month, I will further reduce their rate another $10 per hour. If you are going to offer discounts, it’s important to account for that in your rate up front.
Giving a bonus for paying early versus a penalty for paying late. People don’t like payment penalties, and forcing your client to pay them is something that strains your relationship with them. Rather than impose a penalty, I prefer to offer a reward to clients who pay early. Thus the $10 an hour rate decrease if the invoice is paid within 15 days. If they don’t pay within the 15 days, I will generally give them to 30 days to pay the invoice. If they don’t pay within 30 days, they get an additional 15 days grace period, during which time I will be contacting them frequently. At the end of 45 days, all work ceases until payment is made. It’s important to be firm with this rule, if you let clients string out their payments to you, they will do it. By letting them delay payment, you are in effect financing their business. That’s not something I’m prepared to do, so it’s important to limit your risk and be extremely clear and direct when dealing with business owners. Do not dance around this issue, many a small business has failed because they weren’t good at collecting their accounts receivable (money owed to you).
I add those two discounts into my rate directly so the final billable rate for our example is $120 per hour.
There are a lot of assumptions built into these equations, and as your run your business you will be able to refine them as go along. Just make sure not to start by offering too low of an hourly rate. My initial thought would have had me charging $50 per hour for our example, my actual salary would have been $37,000 a year once we figure in all the business costs. Ouch!
Good luck and happy consulting.