Many new consultants incorrectly estimate their hourly billing rate. They frequently underestimate operating costs and overestimate billable hours. But there is a simple five-step formula for calculating your hourly billing rate.
1. Estimate net billable hours
2. Determine your annual salary
3. Forecast operating expenses
4. Set target profit margin
5. Divide (annual salary + operating expenses + profit) / net billable hours
Net Billable Hours
What are billable hours? Billable hours are the number of hours you’ll work and get paid for. A general formula to estimate your billable hours is to begin with the assumption there are 260 workdays a year and if you worked eight hours per day the total hours worked in a year would be 2,080.
But most people take some time off for holidays, vacations, and sick time. To account for these, you should subtract an estimate of the number of holidays you expect to take (e.g. 10 days), vacation days (e.g. 10 days), and sick time (e.g. 5 days). That leaves 235 workdays in a year.
However, you will spend at least a portion of this time (25% to 35%) on activities you can’t bill the clients for, such as accounting and billing, marketing your business, attending business meetings, and professional education. That leaves 150 to 175 billable workdays (1,220 to 1,410 hours) in a year.
To determine how much your labor is worth, you can use what you earned when you were an employee, or how much you would reasonably like to make. For this example, we will use $120,000.
Operating expense includes advertising, employee insurance, legal and accounting, meals and entertainment, memberships, office supplies, postage and delivery costs, rent, taxes, telephone, travel expenditures, and utilities.
Gross Up for Profit
Next you should set a target profit margin for your business. Profit margin is a measure of profitability. It refers to the percentage of revenues remaining after all expenses of the business have been deducted. There is no standard profit margin, but a 10% to 20% profit margin is common.
Example: assume a 15% profit margin. The total gross up for profit would be $27,000. This is equal to your revenue target. You divide by 1 minus your profit margin target to get the full margin.
Salary + operating expenses = $120,000 + $32,700 = $152,700
Gross Up for profit = $152,700 / 85% = $179,600 - $152,700
Gross Up for profit = $26,947.
Finally, you divide the total labor plus expenses plus profit by your billable hours to arrive at an hourly billing rate of $136.51 per hour. You would generally round this number to say $135 per hour.
If possible, you should investigate the marketplace to see if you should adjust your rate up or down.
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