Any time you are acting as a Freelancer or Independent Contractor, whether you’re doing public speaking, consultancy or as an HR specialist, you are going to be responsible for setting your own rates and getting paid a wage commensurate with your abilities and needs.
Many people who jump in quickly find that at the end of the day, the amount of money left over after their gigs is considerably less than what they had asked for, and this can be surprising. So it pays to take a page from the old Entrepreneurs’ book, and decide upon your minimum acceptable pay, based on your lifestyle and experience.
This means in practice working your way back from what you want to be left with, cash-in-hand, through the various costs and taxes until you wind up at an acceptable remuneration. This is called a Cost-Based Rate, but is only the start!
Step 1: Analyse Your Lifestyle
The main reason to earn money is to be able to live. So your first step is to determine what you are spending on a monthly and annual basis. This calculation should include rent, food, utilities, transportation, clothing, medical checkups – the works. A good way of doing this is simply keeping track of your monthly expenses and using this for a monthly and annual tally.
Don’t forget that to live a care-free life, you probably also want to have a small emergency fund for when an appliance breaks down or you need to pay a big fine or the like. The amount of money will vary by your country and lifestyle, but I’d recommend keeping a savings of about 500 dollars or euros if you have a rental home, and 1000-5000 dollars or euros if you are a home owner. This is on the count of home owners needing to fix up their roofs or fix a leaky basement, which requires them to have a larger emergency fund.
Another thing to keep in mind is being able to save up a little. Your current lifestyle might be fine for you now, but you might want to buy a home, start a family or invest in your own business later on, and that will require some startup funds. Adding all this together gives you a Net wage after taxes.
Net Wage after taxes = Living Expenses + Savings +/- Tax Result
Step 2: Determine Hidden Costs And Insurances
If you are a Freelancer or Entrepreneur, you are not likely to be protected by many social securities. Unemployment, sick leave, disability, pensions and holidays are all things you are responsible for yourself. This means you will need to take out insurances on these and add them as a cost and it can be a lot of money. When you’re a Freelancer, you don’t get paid if you aren’t actually out working, meaning that you need to effectively save up for holidays, sick leave and time between clients.
When you are a Freelancer or Entrepreneur running their own business, you need to make sure how the tax laws work concerning deductibles. In many countries, this means that you get to deduct any costs directly related to the business and deduct them from your gross income/revenue, so you effectively pay lower taxes. See the next step.
Step 3: Consider Business Costs and Taxes
Income taxes will be the primary thing to take into account here, but it may also include taxes on revenue if you are running your own company, or additional taxes to be paid if your car counts as a company car, which is part of your effective wage. Value Added Tax (VAT) is something you need to keep track of – find out what the current rate is for your sector, and make sure to know if you need to pay it, when, and how to charge it properly to your customer.
Other business costs might include costs for your website, registration at the chamber of commerce, travel to your work location, and education needed to stay up to date on your specialization. Marketing and advertising might also come into play as well. Anything that is directly related to you running a business is a business cost, and that can be important – at the very least because it might be a tax deductible (see step 2).
A difference here can exist between Freelances, whose revenue is basically the same as their gross wage, and if you have started a company (incorporated). In the second case, you may first have to pay corporate tax, and then pay income tax on the wages you draw from the company. If this is the case, you need to take this extra step into account when setting your tax result.
This is different per country, and can get quite complicated. My recommendation is always to have an accountant to check your finances and taxes, at least once per year.
Tax Result = Income Tax + Corporate Tax + VAT + Business Costs – Deductibles
Step 4: Determining Your Minimum Gross Revenue
When you’ve summed up all the transformations your rates will be going through, you can start calculating what you want to charge your customers. First, you need to take all the costs you calculated in the earlier steps (so living expenses, savings, business costs, taxes) and create an hourly, monthly and annual “target” for yourself.
Most likely you will have a monthly summary of your expenses, most people do. If so, simply multiply by twelve for an annual target, and divide by (30 days times 8 work hours) 240 to get an hourly target. This is the absolute minimum you should charge for your services to be able to pay for your life.
For example, if you have total living expenses for 2000 euros, 200 euros in business costs, 100 euros in savings, 120 euros in insurances and 400 euros in taxes minus deductibles it would come to a grand total of 2820 euros per month. This means an annual target of 33.840 euros and an hourly target of about 12 euros.
But that does not mean that this is what you charge for your services – this is the minimum to live on. Take into consideration that as an Entrepreneur, you may not have a steady 9-to-5 job and may need to tide over periods without work. This is why it’s safest to charge an hourly rate, because it’s predictable, but you may need to take into account the time in between jobs when setting your rate. Likewise, if you charge a fixed-fee for a project, and estimate the amount of hours it will cost, always high-ball the number (1.5x) or add in a clause that says that additional hours are compensated separately.
Minimum Gross Revenue = Net Wage including Tax Result per work hour, month or year
Step 5: Determining Your Market Rate
The next step is to determine what the going market rate is for your services. You could ask around, find people doing your job Freelance or people hiring Freelancers and see if you can get some straight numbers. Sites like Glassdoor may help to determine the rates here as well. Take into account that if you do, these people are often in fixed employment, and don’t pay the same taxes and insurances you do – make sure to compare their net wage with your own, not gross revenue with their salary.
This will give you the Market Rate for your services, meaning what people are willing to pay a person with your expertise and experience. The more sources you have of information, and the closer they are to your own level of maturity, the better and more accurate this will be. In many cases, you will find the market rate to be somewhat higher than your minimum rate.
Step 6: Determining Your Added Value
This is a much more tricky and nebulous number – here you will need to know your client and the work you will do. Based on how specialized, unique or in-demand your expertise is, you will be able to charge a higher rate. Often, this feeling won’t come until you’ve done a number of jobs for clients, and a few years of experience where you’ve under- or overcharged, or your asking price was rejected, to know what kind of pay you can ask as an individual.
In almost all cases, your Added Value is much higher than either your minimum or your market rates. Consider then a bandwidth between your Added Value Rate (highest) and Minimum Acceptable Rate (lowest). If you feel confident and offer unique benefits to customers, you can move up the bandwidth from the market rate up to the added value. If your services are more common, perhaps you need to charge between market rate and minimum acceptable – at least until you’ve gained more reputation and credibility.
Conclusion
Doing this calculation at least once per year (taking into account how markets, taxes and businesses change) means you will always have a living wage even after the dense forest of business costs and taxation.
This exercise isn’t just healthy for your paycheck, it can also tell you when your sector has known issues. If you find that your market rate is consistently below your minimum rate, you know there’s a problem. A market rate very close to your added value rate means there’s great opportunities to make money with your skill set. Analysis isn’t just numbers, it also means getting a glimpse of the future and allowing you to correct for it!