How to price your services to attract business and make a profit.
Independent contractors (ICs) can charge for their services in a variety of ways, such as a fixed amount for an entire project, an hourly fee, or a sales commission.
No matter how you bill clients, however, you first need to figure out how much to charge -- even if you charge a fixed fee for the whole project. You can't determine how much your fixed fee should be unless you know roughly how many hours the job will take and what you need to earn per hour to make it worth your while.
If you're experienced in your field, you probably already know what to charge because you are 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.
- Investigate the marketplace to see if you should adjust your rate up or down.
Calculate Your Hourly Rate
Business schools teach a standard formula for determining an hourly rate: Add up your labor and overhead costs, add the profit you want to earn, then 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 get by on less.
Determine your annual salary. 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 (as long as your goal is reasonable).
Compute annual overheard. Next, compute your annual overhead. Overhead includes all of the costs you incur to do business -- for example:
- telephone expenses
- office equipment and furniture
- rent and utilities
- stationery and supplies
- postage and delivery costs
- clerical help
- business insurance
- business-related meals and entertainment
- travel expenses
- professional association memberships
- legal and accounting fees, and
- advertising and marketing costs -- for example, the cost of a website, business cards, or brochure.
Overhead also includes the cost of your fringe benefits, such as medical insurance, disability insurance, and retirement benefits, as well as your income taxes and self-employment taxes.
If you're just starting out, you'll have to estimate these expenses or ask other ICs in the same field what they pay in overhead, then use that amount in your calculations.
Choose a profit margin. You're also entitled to earn a profit over and above your salary and overhead expenses. Your salary does not count as profit; it's one of the costs of doing business. Profit is the reward you get for taking the risks of 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.
Determine billable hours. 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 each year, you'll have a maximum of 2,000 billable hours per year (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% to 35% of your time on tasks that you can't bill to clients, such as bookkeeping and billing, drumming up business, and upgrading your skills. This means you'll probably have only 1,300 to 1,500 hours for which you can get paid each year, if you still want that two-week vacation.
Example
Sam, a self-employed website designer, earned $100,000 per year as an employee and feels that he should receive at least the same annual salary as an IC. He estimates that his annual overhead will be about $20,000 per year. He wants to earn a 10% profit and estimates that he'll work about 1,500 billable hours each year. Sam determines his hourly rate as follows:
- He adds his salary and overhead together: $100,000 + $20,000 = $120,000.
- He then multiplies this total by his 10% profit margin and adds this amount to his salary and overhead: 10% of $120,000 = $12,000; $120,000 + $12,000 = $132,000.
- Finally, he divides the total by his annual billable hours to arrive at his hourly rate: $132,000 ÷ 1,500 = $88.
Sam rounds his hourly rate off to $90. However, depending on market conditions, Sam might be able to charge more -- or he might have to accept less.
Investigate the Marketplace
It's not enough to calculate how much you'd like to earn per hour: You also need to determine whether this figure is realistic. This means that you'll have to go out into the world and find out what other ICs are charging for similar services -- and what your potential clients 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 can find out what many companies pay employees who do work similar to yours on websites like www.salary.com, www.gassdoor.com, and www.payscale.com.
You may discover that your ideal hourly rate is higher than what other ICs are charging 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 charge. Lowballing your fees won't necessarily get you business. Many potential clients believe that 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, 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 enable you to get enough work while adequately compensating you for your services.
Make a Written Fee Agreement
Once you decide what you will charge, make sure you enter into a written fee agreement with every client. (If you choose to charge a fixed fee for a project, multiply your estimated hours for a job by your chosen hourly rate.)
For information on creating a solid written agreement, see Nolo's article Use Written Service Contracts for Your Clients.
Next Step
To learn more about pricing your work and other issues affecting ICs, get , by Stephen Fishman (Nolo).
