If you are starting your own business — be it freelancing part time or something you hope would allow you to leave your full time job, one of the questions you will face is “How do I determine my rate?” or “How much should I charge for my work?”

One of the reasons businesses fail is due to having a rate which doesn’t allow the business to be self sufficient in paying the bills including taxes.

Allow me to share with you lessons I’ve learned over the past 17 years with how to determine your hourly rate.

Let’s start off with a homework assignment.

  • What is your target annual salary including benefits (this must be a dollar figure, not a list of what benefits)?
  • If your business were to take off, what job functions would you need to hire employees to cover?
  • Would those job functions be directly involved in producing revenue (eg production worker or sales / marketing that generates work for production worker(s) or overhead (eg book keeping)?
  • What is the going annual pay rate for those positions (even if just an hourly job, take estimated hours they will work in a year times the hourly rate; do include benefits in the overall annual figure)? Your local Chamber of Commerce and library may have this information for you (just ask).
  • What are the hourly rates charged by those with whom you would be competing? What’s the lowest? What’s the highest? What’s the median? What’s the average? You can often find out this information in various LinkedIn groups as well as associated business forums.
  • For the type of business you will be doing, what are the annual fees of any licenses, insurance, etc. as well as other direct costs of doing business?
  • How does the quality of your work compare to those with whom you would be competing?

Part of asking these questions will be working towards a means test — measure twice, saw once — as raising rates down the road may not be feasible.

Now, let’s deal with the simple part — what if you are gong to be a Soloprenuer (this is extremely legitimate) or otherwise a one person business?

In that case take the very first number — What is your target annual salary including benefits — and divide it by 1,000. That will be your base hourly rate.

Where does the 1,000 come from? Are there not 2,080 hours in a business year? Well, yes; but, if you take vacation and allow yourself sick and personal days, you are down to 2,000 hours.

Out of the 2,000 remaining hours comes marketing, networking, connecting, writing proposals, follow ups, cold calling, follow ups, administrative tasks, and finally billable work for which your goal should be at least 1,000 hours.

Chances are high that in your first one to several years, you might spend 500 hours on billable work; and you may want to consider that as part of determining your rate.

If your target salary plus benefits is $75,000.00 (keep in mind health care is very expensive), then you are looking at billing out at $75.00 per hour ($75,000 / 1,000) as a ball park rate.

From here, compare to your competition; but do not short yourself if they are charging the same or less. Look at the values you bring to the table.

By the way, if your competitors normally does packages and and all you can get from your competition is package pricing, realize that time almost always goes into creating, developing, and implementing the package. Try to find how long they take, and then you can determine the hourly rate. Also, how long would you take to create, develop, implement the same thing? Where would you be better? faster? more accurate? a better investment? why?

As you are doing your homework in these areas, what are your direct and indirect costs? The direct ones should be factored into your rate. The indirect ones should also be incorporated into your rate if the indirect fee is not something you would pay anyway if you were not in business for yourself (i.e. you typically don’t include your meals as part of the cost of running your business).

So, how do you adjust that ball park hourly rate for your other costs? You convert them to yearly, then divide the the same $1,000.00. Then add this to your ball park.

Let’s chart this out:

Item Amount Hourly
Salary plus benefits $75,000.00 $75.00
Office $12,000.00 $12.00
Web site (hosting, maintenance, etc.) $500.00 $0.50
Misc. $6000.00 $6.00
Totals $93,500.00 $93.50

The idea, for you, is to do your best to chart out what it will take; and then convert them into what should be your rate based on billing out at least 1,000 hours per year. FYI, this is a good area to get your accountant involved, check out small business books dealing with common business costs from the library, and check with your local chamber of commerce.

Once you start gathering numbers, the above gets to be extremely easy.

Where things can get complicated is when you get to the point where will move from Soloprenuer to where you have employees working for you. In that case, employees fall into one of three categories:

  1. They generate sales for you and whomever else is doing the production work to ensure you have 1,000 or more billable hours. If it is just the two of you, billable hours should be 1,200 to 1,600 hours per year. While your divisor now goes up from 1,000 to as much as 1,600 (early on, I would use 1,200 to start until you get a handle on how much of a sales increase the person does bring in), you will need to incorporate their salary plus benefits plus costs.
  2. They are production workers who do the billable work. While you might find production workers who can get their own 1,000 or more billable hours, generally the production worker just works on production. For a two person operation, that puts you in sales and marketing where you would need to make sure the production person has 1,200 to 1,600 hours per year of billable work.
  3. Back end support – office management, accounting, clerical, but possibly I.T. or related if your business line requires such to help in what you do. This last group, while often vital based on where you are at with the growth of your business, is 100% overhead. This means their salaries plus benefits plus any other costs need to be added into the hourly rate.

The above is where I’ve seen a number of businesses fail over the years. The business starts off as a one person operation who realizes once the business starts to take off, they need one to several more people working the dream with them, but either cannot afford to pay them because their rates are so low, or do pay them the going rates, but run out of cash and end up in a lot of debt.

What’s your take on the math for handling a consulting type business (you get paid by the hour; you and your team are the product / service) for when there are two employees (one sales, one production or potentially one of each)? When there are three employees (one sales, two production)?

Let me know in the comments below.