The cost-based method of bill rate calculation takes into account the total cost of offering your independent consulting or contracting services to the open market.
The real cost of your services is just one point of reference, but is a valuable way to find what is known as your bill rate floor.
We’ll also help you understand an important concept called utilization – the percentage of time that you can actually bill clients.
By using the cost-based methodology, you’ll be able to develop confidence in your rate, as you will know the exact variable and fixed costs that you need to cover to being generating profit.
There are several steps to figuring out a cost-based rate.
Costs consist of labor, taxes and benefits and overheads; these can also be known as fixed vs. variable costs.
Instead of considering just salary (that is, how much you are currently paid as a full time employee for your work), you must instead consider the cost of your services or the labor cost in the open market. A good way to determine this is to ask: How much would you have to pay to do this project if you were to hire someone? Once you have your labor cost, now add on all the benefits that are generally required or expected of an employer such as employer payroll taxes (the employer’s share of Social Security tax and Medicare), workers compensation insurance, unemployment insurance and contributions to health insurance and retirement savings.
As a self-employed professional, you will be responsible for procuring your own health insurance, implementing your own retirement program and you are required to fund both the employers and the employee’s share of Social Security and Medicare Taxes (also known as Self-Employment Tax). Many clients will also require insurances such as Worker’s Compensation and professional business insurances specific to your industry.
Don’t skimp here for the sake of lowering your costs, as these are fixed-cost items that, even with proper deductions and tax benefits, can’t be entirely eliminated.
You'll also have overhead costs. Overhead can be a vast and varied laundry list of things that can range from office supplies, computer systems and marketing to professional advisors, training and licensing fees.
As each consulting practice varies, you should carefully consider the things you need to run shop in your line of business that you can’t charge back directly to your clients.
In building the blocks to an hourly billing rate, you can and should calculate your utilization, a number that takes into account how many hours you are actually billing as a function of how many hours you have available for work.
Typically the large consulting firms target a utilization rate of 70% to 80%. The remaining 20% to 30% is used for business development, business administration, professional development, holidays and personal time off.
But because no one can, and certainly no one should, work every hour of every day of the year, start backing away from this number until you reach a figure that is both realistic and reasonable.
Be generous to yourself and allocate the time you need to recharge, reboot and revitalize. Remember, many people choose self-employment because it offers greater work life flexibility. Build that time into your rate. When you have arrived at your own total number of available hours, you are halfway to utilization.
At this stage, you should have calculated or understand how to calculate your bill rate cost, or the point at which your bill rate can begin to turn a profit.
Let’s find this:
You’re in business to make a profit. You’ve taken risk in even considering going independent and you need to be rewarded for it. In addition to your bill rate cost, your final hourly bill rate is a function of cost plus a supportable profit mark-up.
Your risk is based on the reality that you may not be able to bill all the hours you plan, or you may incur more costs than you planned, or you may have a client that does not pay their bills.
If you accurately factored all of your costs, and also accurately forecasted your billable hours and utilization, a reasonable profit could be 20% to 30%—your markup.
Learn more valuable information, including detailed charts and graphs on how exactly to calculate your rate using the Cost-Based Method, in the free guide below.
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