If you're experienced in your field, you probably already know what to charge because you are very familiar with market conditions. However, if you're just starting out, you may have no idea what you can or should charge. If you're in this boat, try using a two-step approach to determine your hourly rate:
- calculate what your rate should be based on your expenses, and
- then investigate the marketplace to see if you should adjust your rate up or down.
~Hourly rate based on expenses
A standard formula taught in business schools for determining an hourly rate is to add together your labor and overhead costs, then add the profit you want to earn and divide the total by your hours worked. This is the minimum you must charge to pay your expenses, pay yourself a salary and earn a profit. Depending on market conditions, you may be able to charge more for your services or you might have to charge less.
To determine how much your labor is worth, pick a figure for your annual salary. This can be what you earned for doing similar work when you were an employee, what other employees earn for similar work or how much you'd like to earn.Next, compute you annual overhead. Overhead includes all the costs you incur to do business -- for example:
- rent and utilities
- business insurance
- stationery and supplies
- postage and delivery costs
- office equipment and furniture
- clerical help
- travel expenses
- professional association memberships
- legal and accounting fees
- telephone expenses
- business-related meals and entertainment, and
- advertising and marketing costs -- for example, the cost of a yellow pages ad or brochure.
Overhead also includes the cost of your fringe benefits such as medical insurance, disability insurance and retirement fund. Also include your income and self-employment taxes.
~If you're just starting out, you'll have to estimate these expenses or ask other ICs what their overhead is and use that amount. You're also entitled to earn a profit over and above your labor and overhead expenses. Your salary does not include profit; it's part of your costs. Profit is the reward you get for taking the risks involved in being in business for yourself. It also provides money to expand and develop your business. Profit is usually expressed as a percentage of total costs. There is no standard profit percentage; but a 10% to 20% profit is common.
Finally, you need to determine how many hours you'll work and get paid for during the year. Assume you'll work a 40-hour week for purposes of this calculation, although you may end up working more than this. If you want to take a two-week vacation, you'll have a maximum of 2,000 billable hours (50 weeks x 40 hours). If you want to take a longer vacation, you'll have fewer billable hours.
However, you'll probably spend at least 25 percent to 35 percent of your time on tasks such as bookkeeping and billing, marketing your services, upgrading your skills and doing other things you can't bill to clients. This means you'll likely have at most 1,300 to 1,500 hours for which you can get paid each year if you want to take a two-week vacation.
- Example: Sam, a self-employed computer programmer, earned a $50,000 salary as an employee and feels he should receive at least the same salary as an IC. He estimates that his annual overhead amounts to $20,000 per year. He wants to earn a 10 percent profit and estimates he'll have 1,500 billable hours each year. Sam determines his hourly rate as follows:
- he adds his salary and overhead together: $50,000 + $20,000 = $70,000
- he then multiplies this total by his 10% profit margin and adds the amount to his salary and overhead: $70,000 x 10% = $7,000; $70,000 + $7,000 = $77,000, and
- he divides the total by his annual billable hours: $77,000/1500 = $51.33.
Sam determines that his hourly rate should be $51.33. He rounds this off to $50. However, depending on market conditions, Sam might realistically charge more or less.
Investigate the marketplace
It's not enough to calculate how much you'd like to earn per hour. You have to determine whether this figure is realistic. This requires that you go out into the world and find out what other ICs are charging for similar services and what the clients you'd like to work for are willing to pay. There are many ways to gather this information.
- Contact a professional organization or trade association for your field. It may be able to give you good information on what other ICs are charging in your area.
- Ask other ICs what they charge. You can communicate pricing concerns with other ICs over the Internet.
- Talk to potential clients and customers -- for example, attend trade shows and business conventions.
You may discover that you likely can't get your ideal hourly rate because other ICs are charging less in your area. However, if you're highly skilled and performing work of unusually high quality, don't be afraid to ask for more than other ICs with lesser skills do. Lowballing your fees won't necessarily get you business. Many potential clients believe they get what they pay for and are willing to pay more for quality.
One approach is to start out charging a fee that is at the lower end of the spectrum for ICs performing similar services and then gradually increase it until you start meeting price resistance. Over time, you should be able to find a payment method and fee structure that enables you to get enough work and that adequately compensates for your services.
Here's advice to help you decide what to charge for your services. Independent contractors -- ICs -- can be paid in a variety of ways, including a fixed fee for an entire project, payment by the hour or payment by sales commissions. However you're paid, you need to determine how much to charge per hour. This is so even if you're paid a fixed fee for an entire project. To determine the amount of a fixed fee, you must estimate how many hours the job will take and multiply the total by your hourly rate then add the amount of your expenses.