Perhaps you’ve just been laid off, or your boss crossed the line one last time. That’s it. You’ve had it and you’re going to become your own boss. Whatever the reason, if you’re considering hanging out your shingle as an independent consultant, one of the first questions you’ll need to answer is – how do you set your consulting rates? This article will clue you in on what factors you must take into account when setting your hourly consulting rates. Another article addresses how to use your hourly rate to quote fixed price jobs.
Setting Hourly Consulting Rates – How Many Hours Should You Expect to Bill?
A typical figure thrown around for annual work hours is 2000. That’s 50 full-time weeks of 9 to 5 work. Some brand-new consultants or freelancers set their hourly rates by taking their most recent annual salary and dividing it by those 2000 hours. That’s a big mistake that leads to severely under-pricing consulting services.
Most employees (except those in high-pressure jobs) work fewer than 2000 hours per year. Holidays, sick leave, annual vacation days, etc. reduce the number of annual work hours to about 1750. So, you might decide to divide your most recent annual salary by these 1750 hours, right? Wrong. Unless you’ve already lined up enough clients, or have set yourself up with a full-time consulting gig, you need to account not only for those times you want or need to take time off for holidays or sick days, you must also take into account days (or weeks) of slow work, hours for marketing efforts, etc. A more reasonable number, at least at first, would be 1000 hours a year.
Setting Hourly Consulting Rates – What’s the Minimum You Can Live With?
If you’re planning to be your own boss, you need to be comfortable with budgets. The first budget you need to make is your personal or family budget. How much do you need to live on? Don’t forget to add in your health insurance and any long term and/or short term disability premiums you have to pay. You should also be setting aside money for a rainy day and for retirement, so include that as a budget item. If your spouse has his or her own income, subtract that income from your budget and write down the difference. For our purposes let’s assume you need to make at least $50,000 per year. That’s what your bottom line consulting profit after taxes will have to meet or exceed.
Another article which compares salary income to consulting or freelance income, will clue you in on how to estimate your taxes from your top-line revenue and expenses. However, here we’ll simply estimate that you should add about 1/3 on top of the above $50,000 to account for income and self-employment taxes. This is not a precise number, but should be fairly close. For our example that works out to about $67,000. If your specific needs are much higher you may need to add as much as half to your needs to account for the higher tax bracket you’ll find yourself in.
This brings us to the next budget you need to work out – your business expenses. Take into account costs such as marketing and advertising expenses, office rent, utilities, supplies, equipment, continuing education and/or professional licensing and dues as appropriate for your type of consulting or private practice. If you use other professionals to advise you on legal matters, financial matters, clean your office, and/or carry out repairs and maintenance for you, make sure to include those. Add all these to your pre-tax amount ($67,000 in our example) to get the top-line revenue your consulting or freelancing will need to bring in. If your business expenses are about $1500 per month, or $18,000 per year, your top-line revenue will need to be higher than $85,000.
The Last Step of Setting your Consulting Rates
Dividing the total revenue you need ($85,000 in our example) by the number of billable hours you expect to have (1000 in the above) brings you to an hourly consulting rate of $85. You may be able to set your rates higher by charging what other professionals with comparable credentials in your line of business charge, in which case by all means do so. After all, you face more risks as an independent consultant than does an employee. However, if you charge less than the result of the above calculation with your specific numbers, you will lose money. If your competition is significantly cheaper, you may have to reconsider being a consultant or freelancer, reduce your business or personal expenses, and/or accept you won’t be able to make ends meet until and unless you bill more hours.
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