Ask any freelancer and I’ll bet you they’ve all had problems figuring out what to charge. I certainly had.
Do I go by the industry average? Can I even do that if I don’t have the same experience as my competitors? Do I lower my rates to get the clients to contact me instead of other freelancers? and do I really have to compete with the $5 freelancers in Asia?
Are these questions even the right ones to be asking? If you don’t need to survive as a freelancer, yea they might be okay. But if you want to work and live as a freelancer full time then you need a completely different approach to setting your rate and guess what. I’ll take you through it starting from the end of this sentence.
There are basically two things that dictate what you should charge:
1# How much do you actually need to make to continue your lifestyle and create a good future?
2# How much are you actually able to work?
These are the only two things you need to know to set your rate and I’ll show you how to calculate them here below.
Figuring out the cost of your lifestyle
I see so many freelancers give advice on how to decide what to charge and so few of them actually take your life into account. Why is this so important? Because you need to live on the income you make! It’s not all about what you’d like to charge and the numbers of hours you’d like to work. The math is more complex and should always be calculated with your lifestyle in mind.
I’ll take you through several points where it might be beneficial for you to take notes. You could also download my Minimum hourly rate calculator spreadsheet and let the computer do all the calculating for you.
Your living expenses
We’ll start off with the most essential, your living expenses. Whether you’re starting a freelancing career or want to take it a step further, you’ll most likely want to be able to continue your current living situation, so let’s start off by calculating how big of an income you need to make on a monthly basis.
This can be done in 4 easy steps:
- Take a look at your bank statements from the previous year and write down all the expenses you had. Ideally, you would categorize your expenses to create a good overview of how much you’re spending on things like going out, house expenses like a loan, rent, renovation and things like transport, food etc.
- Calculate a monthly average for all the different categories you’ve created.
- Sum it all up and you’ll have your monthly needed income. If you decided not to separate your spendings over the last year, just calculate the average monthly spend.
- Now add 20-30% – Why? Because it’s better to be on the safe side than living on the edge and having a buffer will come in handy some day.
If you’re dreaming of living a more expensive lifestyle than you currently are, then just calculate with estimations on how much you need to live that dream lifestyle.
Until now you’ve calculated what you need to receive on your bank account every month to make a living, but that’s after-tax money. We need to find out what you have to make pre-tax.
The tax rate you need to pay depends on where you live and what you do which makes it impossible for me to calculate it for you. But if you roughly now what you have to pay in taxes you can multiply your monthly needed income with that tax percentage. (If you’ve downloaded the spreadsheet it will do all this for you.)
I’ve created a personal example:
Monthly needed income: $3,300
Average tax percentage in Denmark: 42%
Calculation: ( [Needed income] / ( 1 – [Tax percentage] )) and with added numbers: (3300/(1-42%))
Income needed before taxes = $5,690
A freelancing business doesn’t cost near the same to operate as a business with hundreds of employees but you will still have business expenses and these needs to be calculated into your needed monthly income.
It’s not easy to calculate business expenses if you’re new to freelancing but if you’ve been freelancing for a while you most likely know the most of the costs you have on a monthly/yearly basis. If not, then I recommend you do your best attempt at estimating and ideally you’ll add 20-30% as a safety margin.
First of all, ask yourself what tools you need to do your work. I’ve listed a few of my tools to give you an idea of what I mean.
- Macbook Pro
- Pen and Paper
- Different types of marketing software
- Internet connection
- Skype number + credit
- Accounting software etc.
Next, you need to think about what they’ll cost you. Do you already own some of these tools or are they something that you’ll pay a monthly, yearly or one-time fee for using? A laptop, for example, may only have a lifespan of 3-4 years. So for every 3-4 years, you need to have saved up enough money to buy a new one.
Then there are all the typical business expenses:
- Accounting / Bookkeeping
- IT equipment
- Legal help
- Office supplies
- Bank charges
- Marketing costs
This list is by no means definitive. Your business is unique and therefore your expenses are unique. The main point though is that you need to think about what you’ll be needing on a daily, monthly and yearly basis and then find the average monthly expense of these things.
A point that’s also worth mentioning is that you are likely to be able to write-off many of these business expenses but please contact a specialist as they are the only ones who will be able to give you qualified advice on this as it again depends on the laws you operate under.
For the sake of simplicity, I encourage you to just write down your average monthly business expenses + safety margin and continue. Don’t speculate in write-offs for now as you’ll be on the safe side by not taking them into account.
Just to add a number for further calculation example further down, let’s just say that I have a monthly business expense of $350.
Plan for the future as well
There is one point in particular that very few actually think about, but down the line, you’ll be so grateful that you did.
What I’m talking about is your future.
Are you going to retire and grow old? If your answer is “most likely” or “hopefully” then you should plan for your retirement and charge accordingly by adding the monthly retirement deposit into your rate.
Being a Danish citizen I have no idea how a 401K or Roth IRA works or how the rules are for this, but I bet you know a little about what you should be saving up on a monthly basis.
What’s also worth thinking about is whether or not you’re going to hire someone down the line? Most of us will end up hiring someone to either free up time or generate a bigger business/income.
If you’re only getting by on your monthly income it’s hard to hire someone as you need to pay them from the money you are supposed to live on. Therefore I highly recommend that you at least put aside a few hundred dollars a month to be ready for this when the time arrives. Having a buffer never hurt anyone and will make the transition to hiring somebody much easier.
Whether or not your future expenses needs to be calculated before/after taxes are again dependable on your countries laws and your situation. You might even be able to write some of it off.
In my case, it would all be pre-tax income and let’s just say that I would save up $800 a month for this.
By now you should have noted 3 total sums up.
– Your monthly personal expenses ($5,690)
– Your monthly business expenses ($350)
– Your monthly future expenses ($800)
Add all these numbers together and you’ll know what you need to make on a monthly basis.
Based on figurative numbers I’ve used so far I would need a monthly business income of ($5,690 + $350 + $800) = $6,840
The hourly trap that so few talks about
Normally freelancers would then divide this monthly needed income with the hours they want to work per month and then have their needed hourly rate.
By doing this they’ll often end up working 30-50% more than they planned – They get caught in the hourly trap. If you stay put for not that much longer, I’ll show you how to avoid this trap and calculate a realistic hourly rate that won’t make you work more than you want.
Let me just clear that up for you.
If I had just calculated my hourly rate based on the previous calculations and the fact that I’ll be working 40 hours/week or 160 hours/month then my hourly rate would be $42.75.
But here’s why that’s wrong.
This is based on the fact that you are actually able to bill all your 160 hours every month for the rest of the year.
This is the scary fact of the freelance game
You won’t be able to bill all your working hours!
You’re not just an employee any longer. You are running a business and that means you need to handle more than just the “worker” role. You need to take on all relevant business roles including but not limited to:
- Customer service
- Approaching and selling to new clients
- Business development
- Process optimization
If you have 40 hours/week then at least 10 of these will be used doing other business related stuff. That could be getting new clients, planning your upcoming week, taking phone calls, trying to get some media attention and so forth.
That leaves you with a maximum of 120 billable hours/month but we’re not even close to done yet.
Effective working hours
In a perfect world we would all be working 100% of the time we’re at work, but as you know, it’s not like that at all.
Before we start working we just check emails, In one of the emails, there was a link to an interesting article that we decide to read. When done we go on to youtube to turn on some background music but as youtube is loading we quickly open facebook in a new tab where we got a notification that someone posted in a facebook group we follow and the story continues…
It happens to all of us. It doesn’t even have to be on social media and web-browsing that we waste our time. It could also be by switching between several different tasks trying to multitask.
According to Gerald M. Weinberg’s popular book: Quality Software Management: System Thinking, he proposed a rule of thumb describing the loss of effective working time when switching between tasks.
When you’re working on one project you can focus all your time and work 100% effective. If you’re working on two projects simultaneously, switching between them you are actually losing 20% of your time due to context switching (Having to get into the rhythm, the subject and actually start working). The more projects you switch between in a day or the more frequently you switch between a few, the worse it gets.
Before you can calculate your hourly rate you need to know how many hours you actually work. A good way of finding out is trying one of the time-tracking software like RescueTime. This will monitor your daily activity and show you how much time your spending on different websites/activities.
To keep the momentum going, let’s just say that you are very good at focusing and you are only losing 5 hours a week or 20 hours/month on context switching, mails, disturbing phone calls etc.
That now leaves you with 100 billable hours/week.
Talking from personal experience it is super important to think about taking at least one offline vacation a year. I personally take at least two weeks of offline vacation.
This, of course, needs to be accounted for in your hourly rate as you won’t be making money while being on vacation.
1 week of vacation per year gives you approximately 3,5 billable hours less on a monthly basis.
You’re now down to 96,5 billable hours/month.
What about your health?
Even though you are in great shape you will at some point get either sick, have an accident or have to take time off because someone you hold near is sick.
It’s impossible to predict how much time you’ll be sick in a year but let’s assume that you are sick at least for 12 working hours/year equaled to 1 hour/month.
How many billable hours do you have left?
Yep, only 95,5 hours/month.
Remember that first calculation showing that you needed to make $42.75/hour based on the fact that you could bill 160 hours/month?
By taking all this into account you actually need to charge $71.62/hour. That’s $28,87 more than initially calculated!
What would have happened if you had decided to charge $42.75 an hour? You would end up working a lot more than the 40 hours in order to earn what you need. That’s why so many freelancers are working their ass off to survive.
This is also why you shouldn’t compete on price or in the general marketplace as you can always be beaten by someone in Asia that doesn’t have the same living expenses as you which means that they can work for $5-10/hour.
Instead, you need to focus on finding the clients that are able and willing to spend more and luckily there are more than enough of these clients out there.
I hope this was of value to you. If you have any thoughts, questions or recommendations I’d love to continue the conversation below in the comments.