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How to determine your hourly rate as an entrepreneur

26 June 2017 by National Bank
It’s time to set aside your emotions to rationally calculate your hourly rate.

It’s time to set aside your emotions to rationally calculate your hourly rate as an entrepreneur.

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“What is your hourly rate?” That is the million-dollar question for entrepreneurs torn between asking for a low amount in order to obtain contracts and requesting a rate high enough to turn an interesting profit. But what if you simply calculated your optimal hourly rate?

This is what Valérie Parizeault did about five years after launching her business, Studio Rose Flash, a company specializing in websites and brand image. She decided to share the strategy she used for calculating her rate on her blog.

“Money is an emotional issue, but at one point, the problem needs to be viewed from a mathematical perspective,” states the entrepreneur.

1- Estimate your business costs

First, calculate how much it costs to run your business. Depending on the legal status of your company, costs vary.

For example, if you decide to create a company, the initial incorporation fees are $325, and add to that nearly $100 in annual costs to maintain your company in good standing. You also need to set aside money for extra accounting fees since you will need to file both your personal and business income tax returns.

You should also determine whether you will occasionally require consulting services, or if you will need to hire employees, with the associated payroll taxes they entail such as the Quebec pension plan and employment insurance.

It is also important to take into account all the rest: office space costs, transportation, equipment, furniture, office supplies, telecommunications, insurance, advertising and business development costs, etc.

As an example, let’s say you are not hiring any employees for now and that your expenses are about $25,000 per year.

2 – Estimate personal expenses

You then need to ask yourself how much you’d like to earn per year.

“I recommend entrepreneurs determine both the salary they need to cover living expenses and the amount that they would be happy with in order to get a good idea of the room for manoeuvre,” indicates David Decary, consultant/trainer at

In order to do so, you need to analyze your yearly costs. This of course includes your residence and the price of groceries, but also transportation, vacations, and other personal expenses such as sports and outings. And don’t forget contributions to your registered retirement savings plan (RRSP).

As an example, let’s say that you can live on $40,000, but to really be comfortable you should aim for $60,000.

3- Don’t forget income tax

An important mistake to avoid: forgetting you need to pay income tax! The amount varies according to each individual situation, but David Décary advises setting aside about 20% of your income for taxes. So, in order to earn $60,000, you should aim for about $75,000.

A tip from Valérie Parizeault, seasoned entrepreneur: plan a margin of profit that you can reinvest in your business. For example, to redesign your website, purchase a new computer, go on a business trip, or work for a few months on a project that may not be profitable but is important to you or will give your business exposure.

If you think 15% is sufficient, you are now up to $86,250 per year for a happy entrepreneur.

David Decary, who teaches the course Financial planning in the Starting a business program at the École des entrepreneurs | MTL, recommends setting aside this amount to avoid spending it on anything else.

“If you know you need to buy new equipment or finance an expansion, allocate a budget accordingly,” he notes. “It’s easier to set money aside when you have a tangible objective.”

You can also simply deposit these amounts in a working capital account that you should regularly contribute to.

In sum, you need to earn a salary of $86,250 + $25,000 for the annual business costs calculated at point #1. You are now up to $111,250.

4- Estimate your billable hours

Earning a good salary is nice, but it is also important to make sure you won’t need to work 80 hours a week to get there. So you need to estimate the number of hours worked annually.

Even though many entrepreneurs go into business without taking any vacation in the beginning, this shouldn’t last! A month off per year is not a luxury. And let’s add another week for legal holidays because you will also want to take advantage of these days off at one point.

You are now up to 47 working weeks per year. Let’s say you would like to work 40 hours a week. Count at least 5 hours that are not billable, for example reserved for business development and bookkeeping. You are now at 35 hours. Since we always tend to work more hours than planned, give yourself some leeway by under-estimating. So 30 hours a week for 47 weeks equals 1,410 hours of work a year.

The final calculation

To earn $111,250 in 1,410 hours of work, you need to charge $80 an hour.

If we compare with the minimum required to get by, specifically $40,000 in your pockets rather than $60,000 at the end of the year, the rate would be around $58 an hour.

Now you need to ask yourself whether it’s realistic in your market and how much your competitors charge their clients. If your result is too far from this supply and demand reality, you can try to reduce business costs or your own personal expenses. Or simply plan on working more hours.

“Making these calculations can seem daunting for entrepreneurs in the beginning because they realize that it takes a lot of money to make ends meet, but it quickly reassures them since they can see things as they are and can look for concrete solutions to problems,” notes David Decary.

Don’t worry if your business model is not yet optimal! At first, many entrepreneurs ask for rates that are too low. This was the case for Valérie Parizeault, who often spent double the number of hours estimated on a project during her first years in business.

“But through trial and error, we gain experience and are better able to evaluate our time,” she explains. “Eventually, we want a house, a family, so it’s important to have a business model that works.”

“It’s not enough to have a profitable business,” shares David Decary. “The income generated needs to meet the needs of the entrepreneur.”

And then, you have to learn how to communicate your hourly rate without making it a big deal.

“You shouldn’t be shy, or say that you don’t know, or that it depends,” states Valérie Parizeault. “Money is one of the most important aspects of succeeding in business.”

 

Checklist

  1. A) Calculate the annual operational costs of your business.
  2. B) Calculate the gross salary, including income tax, you need to earn per year.
  3. C) Calculate a profit margin on your income to reinvest in your business.
  4. D) Calculate your billable hours per year.
  5. (A+ B+ C) ÷ D = the hourly rate of a happy entrepreneur

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