A frequent conversation that I have with clients is how much they should charge for the services they will offer. This is particularly true of those whose business will be to provide consulting or a professional service. As an employee of a company, they know how much their salary is, and they may have a good idea of how their current employer bills for their time. However, they don’t often know the true total costs incurred by their employer. As a self-employed person, you will have to cover all of the costs of your employment just to maintain your current income level.
Total costs include both direct costs—salary, benefits, and mandatory contributions for social security and Medicare—and indirect costs, such as office space, office supplies, business insurance, and support staff. It is an interesting, and worthwhile, exercise to calculate these costs.
Let’s calculate your true employment cost, using these assumptions:
- Annual salary is $50,000
- 3 weeks paid vacation
- 12 paid sick and personal days
- 8 paid holidays
- Employer pays for 50% of the costs of your health insurance, at a cost of $1,100 per month
- Employer contributes an additional sum equal to 2% of your salary into your retirement plan
- Employer pays ½ of social security and Medicare expenses at 7.65% of salary
You earn approximately $24 per hour, calculated as $50,000/2,080 paid hours per year. Keep in mind, however, as a self-employed person, you only get paid for billable hours worked. There are no paid vacations or holidays for business owners. To compensate, you need to determine how much you earn per hour based on the number of hours you actually work.
Step 1: Calculate the number of hours you currently actually work per year.
Subtract vacation days, sick leave, and paid holidays from 260 work days per year.
260 – (15+12+8) = 225 days worked
225 * 8 hours = 1,800 hours worked per year
Step 2: Calculate total costs born by employer which you will have to cover:
$50,000 + (1,100*12) + (.02*50,000) + (.0765*50,000) = $68,025
Step 3: Divide true employment cost by actual number of hours worked: $68,025/1,800 = $37.80.
Step 4: Make an adjustment to account for the percentage of time that you will work on non-billable tasks, such as marketing, invoicing, and paying bills. Let’s estimate that you will spend 5 hours per week on administrative tasks and 10 hours per month on networking. That reduces your billable hours to 1,800 – 260 – 120 = 1,420.
Step 5: Rate to charge to cover true employer costs = $68,025/1,420 = $47.90
So, you now know that you will have to charge about double your current hourly rate just to cover the direct employment costs born by your employer.
However, as a self-employed person, you will also have to cover all your business expenses. To keep things simple, let’s assume you will work from home initially, and you estimate that you will spend approximately $800 per month on business insurance, office supplies, licensing and registration, marketing, and auto expenses. Your billable hourly rate needs to be increased to cover $9,600 in annual expense.
Employer costs + operating expenses = $77,625
Rate to cover employer costs and operating expenses = $77,625/1,420 = $54.67
Keep in mind that $54.67 is the rate you need to charge for 1,420 hours of paid work per year to generate the same level of personal income that you are receiving as an employee. It is also important to keep in mind that you will not be guaranteed 1,420 hours of billable work. So, there is some risk involved. To compensate for the risks you will be taking and to provide sufficient income in slow periods, you will need to charge more the $54.67 per hour.
As your business grows, you may need to hire employees and rent office space. At some point, you will hire employees who do not generate revenue to perform such tasks as accounting, human resources, social media, and reception. The rate you bill customers will need to cover all of these expenses. As you consider all the costs of operating a business, you will get a better understanding of how much you need to bill your clients to cover all your business expenses and generate a profit.
If you would like help in determining these costs for your business, the UMW SBDC can help. If you are a client, please contact your consultant to schedule an appointment. If you are not already a client, you may register for free, confidential business assistance by completing a Request for Consulting form on our website, umw.edu/sbdc.