What Should I Charge for My Services?
Finding your optimum charge-out rate is one of the most important calculations you can make.
What should I charge my clients for my services? Without a properly calculated charge-out rate you will not be able to sell enough services to cover your costs and make a profit. The right charge-out rate is the result of a complex interplay between your costs of production and delivery on the one hand and, on the other, the price your customers are willing to pay given market conditions — primarily competition.
Two key components make up the fundamentals of determining a charge-out rate:
1. What income do you, as an individual, need to earn in order to support your personal lifestyle?
2. How many chargeable hours do you anticipate are available for you to work
How Much Do I Need to Earn?
On the first point, you need to know your personal or family cost of living. For example, your experience has shown that you need at least $60,000 in gross income per year to pay your taxes and have enough left over for shelter, food, clothing, transportation and recreation.
2,000 working hours a year will only yield about 1,400 chargeable hours.
How Much Should I Charge Per Hour?
The second issue is chargeable hours. Let's start with 365 days a year and do the math from there. Assume for a moment that weekend work (104 days) is out of the question and another 11 days accommodate statutory holidays and illness. This leaves 250 working days. An eight-hour workday gives 2,000 hours available for work in a year. However, this time is not all chargeable. Within that time frame, there are "time costs" such as marketing, public relations, human resources, financial management, technical delays and training courses that must be considered. It is safe to assume that about 30% of the time available for work is not going to be productive. The 2,000 available hours will probably yield only about 1,400 chargeable hours. It would therefore be a mistake to set a $30 rate based on 2,000 hours to earn a $60,000 gross income. In fact, a charge-out rate of $43 per hour for the 1,400 hours is required to generate $60,000.
Estimating the Future
The next step involves good estimating and a spreadsheet. Not only is it necessary to know the cost for supplies, transportation, utilities, office equipment, bookkeeping, training programs, public relations and advertising (to name a few), but it is also essential to determine when income will be generated and costs incurred during the year. This knowledge will enable you to estimate cash flow needs and the potential requirement to borrow working capital that will precipitate loan interest.
Commercially available spreadsheet programs can set up categories and manipulate data to time cash flows for accounts receivable and accounts payable. For most individuals, however, a spreadsheet indicating month-by-month sales and expenses will suffice.
When completing an income and expense budget, be conservative with sales projections and liberal with expenses. Assuming estimated expenses total $80,000, it is apparent that the break-even point (the point at which expenses and revenue are equal) to operate the business is $140,000 ($80,000 + $60,000). Given the 1,400 chargeable hours available, the minimum requirement to keep the doors open is $100 per hour.
In addition to establishing the charge-out rate needed to break even, individuals should also give consideration to capital costs. Assets such as vehicles, computers and other equipment must be replaced. These costs are often missed in the calculation of a charge-out rate because they are not day-to-day costs. If equipment must be replaced every two or three years, a determination of the hourly cost of that equipment should be calculated and factored into the hourly rate charged.
Factor the Future The future for most businesses is uncertain. For this reason, it is beneficial to ensure that funds are available for a rainy day. In that "breaking even" is a calculation based on current conditions but not the future, charge-out rates should have built-in profit margins. Contemplate a need for a 10%-to-20% profit margin and increase the charge-out rate by that amount. In our example, if the charge-out rate is $120 instead of $100 per hour, the revenue earned on 1,400 hours increases to $168,000 with expenses stagnant at $140,000. This provides a buffer of $28,000 per year.
Beyond the Numbers
Following a process to determine a charge-out rate provides benefits beyond a final number because it:
a) allows determination of whether the business or marketplace can support your business (If not…why would you invest time, money and emotion into a venture that is going to crash?);
b) demonstrates a structured approach to a business venture that will be beneficial if financing is required;
c) provides a chronological projection of the business for a 12-month period to reveal the ups and downs of a business cycle; and
d) induces an understanding of how workload and financial constraints might impact your personal life by demonstrating when cash and time are required. This knowledge, in turn, will impact not only personal spending habits but also determine when you can take time to enjoy that vacation.
Discuss Your Findings with Your Chartered Accountant
Once you are confident the calculations are representative of prospective business activity, it would be prudent to discuss your findings with an impartial advisor such as your local chartered accountant. With their knowledge of the community, they will undoubtedly be able to review your efforts and raise issues you may not have considered. Further, they can provide additional knowledge concerning GST/HST and income tax specific to your proposal. They may also provide guidance on the legal structure of your venture to minimize or defer taxes payable. This information, combined with your efforts, provides additional fodder essential in making the decision best for you.
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