In this video, learn the basics of the foundational method for setting a bill rate, called a cost-based bill rate, and learn how to manually calculate the right price for you and your business.
Today, we’ll learn a simple method for setting your bill rate as an independent consultant. Your bill rate is the amount you or a company charges per hour of work… before taxes, fees and discounts. The process of finding your cost-based rate is simple. First, we’ll show you how to calculate the costs associated with doing business as an independent. Then, we’ll walk through how to calculate how much time is billable. Last, we’ll show you how to plan for losses, and to build in a profit.
The cost-based bill rate method is ideal for new consultants. The cost-based method determines the total cost of offering your services on the open market. Let’s review labor costs. Think of labor costs this way: how much would you pay someone to do this work for you? Labor is what’s known as a variable cost – because it can vary from job to job – for example, you might pay an experienced person $50 per hour for work and a new person $30 per hour. You’ll need to account for taxes and benefits that, as an independent consultant, you’ll need to pay for on your own. Remember, benefits and taxes can be expensive, often running as much as 30% to 50% of your total labor costs.
When you add labor, taxes and benefits, you have your “variable” spend set. To this number, you’ll need to add what’s known as fixed costs. Fixed costs are also known as overhead. These can be things like office space or your computer. Your variable costs plus your fixed costs add up to your total cost of doing business. That number, calculated as a monthly, weekly, or hourly total, is known as your total cost or operating expenses.
Now, we’ll show you how to calculate your billable time. Your billable time is based upon the concept of a utilization rate – how many hours you are billing as a function of how many hours you have available to work. An industry standard is 2,080 hours. That’s 40 hours each week times each of the 52 weeks in a year.
But you can’t work all the time! You’ll need to account for vacation, personal time, and non-billable tasks like administration and marketing. Your total working time each week or month divided by your available working time is your utilization rate. Even if you’re not sure exactly how much time you’ll devote to things like administrative work or vacation, you can make a good general estimation. It’s safe to assume that your billable work takes up between 70 and 80% of your time – perhaps less if you’re managing a family or working part time in retirement. Now that you know how to calculate your minimum bill rate to break even…also called your bill rate “floor,” it’s time to factor in profits and losses.
If you charged only your bill rate floor to your clients, you’d be just breaking even. But you’re running a business – let’s add in a mark up to make a profit! Your mark-up is a percentage that you add to your costs to cover risks, or generate a profit. After all, you’ve worked hard and deserve to reap the benefits of your independent business. It’s also a good idea to set aside cash for a rainy day – such as unexpected time between projects. Keep in mind that your utilization rate is the amount of hours you reasonably can work – not the amount of hours you necessarily will work in a given week or month.
This graphic looks complicated, but it’s a pretty simple calculation. We’ve shown you how to get to the breakeven point, or your bill rate floor, by adding your fixed and variable costs together to show a total cost. Now, you’ll add a percentage to that bill rate to give yourself a cushion, or profit. We’d suggest 5 to 15% above your bill rate floor.
Now that you know the basics of cost-based pricing, you can try it out yourself with MBO Partners’ bill rate calculator. Simply follow the prompts to enter billable and non-billable hours worked per week, necessary expenses and additional variables.
Want to learn more? Find out more about bill rates, including techniques for designing market-based and value-based bill rates by reading our bill rate guide or contact us today at firstname.lastname@example.org.