A few years ago, one of my first business coaching sessions was with an entrepreneur who had spent a year and a half in development. He’d given up a well-paid job and spent about $25,000 on developing an app. He had no real business plan. When I pointed out that he had notionally invested about a quarter of million dollars on the app, he drew a deep breath of entrepreneurial fatigue, and said dishearteningly, “Well, I suppose so.”
This back of the envelope calculation was done as follows:
$150,000 (salary he has forgone p.a.)
x 1.5 (years working on the project)
$225,000 (total salary forgone)
+$25,000 (development outgoings)
Effectively, using a very simple business opportunity cost model, he had invested a quarter of a million dollars in an unfinished app. The app was designed exclusively for the Australian market, and a return on investment would have required taking over 50% of market share.
How much is your time worth?
This little gem of a question is fully loaded with nuances, complications, value judgments and implications. Writing your first estimate can be scary, but getting it accepted and sending your first invoice is exhilarating. It will build your confidence, self-esteem and motivation.
On the flip side, not all your estimates or quotes will be accepted. As a new kid on the block, this may evoke an emotional response: it may knock that same confidence, self-esteem and motivation.
How much should you charge?
Your time is only worth how much people are prepared to pay for it. You should look up industry and employment data, check out your competitors and look at what others with similar experience get paid.
- Be competitive.
Accountants, bookkeepers and other service-oriented providers usually charge on a time basis. Look around, ask your friends what they pay for similar services and go to a competitor website. If you are not charging competitively, you may be pricing yourself out of the market unless you have a unique selling proposition to justify why you are above the average cost.
- Know your costs.
If you are charging per hour, make sure you know the numbers. You need to cover the cost of materials, transport, legal advice, taxes, on-costs, professional memberships and insurance. You need to know your breakeven point and cover these costs early on so you don’t get to the end of the year to find you would have been better off working for someone else, all while worrying less.
- Don’t forget the cost of business development (BD).
Depending on your industry, the time and effort it takes to gain business might be huge and can make or break your business. I find that in the early stages of a startup, the BD investment can be enormous. Sometimes it may take minutes to get a client; other times it may be weeks or a year. You need to account for the time you are not earning fees.
- Add in a risk factor.
After you have ensured you are competitively priced for your unique service and you know what it costs to deliver the service, you should aim to clear what you would earn working for someone else, plus a risk factor for going it alone. Why would you go into business if someone else would pay you the same amount?
- Know the value you add to the client.
Always look to communicate the value you are providing. An alternate approach to charging for time and materials is to charge per project. Ask yourself: “What is the real benefit to the client?” Look at the market rate. If you can solve a major issue, you may be able to charge much more per project than you would make if you charged for time.
Calculating a high-level hourly rate
In another back-of-the-envelope calculation and running with a $10,000 per month salary example, you can work backwards to figure out your necessary fees and decide if you can offer a competitive option for the market. If you choose to run your own business and charge an hourly rate, you then have to decide what your threshold is for taking the risk of starting your own business. The business may fail, your income may plummet, or you could lose the money you invested in the business altogether. So lets say you feel comfortable to take the risk if you earned approximately 50% higher:
$10,000 (your salary package if you were employed elsewhere)
+$5,000 (add your risk premium, say 50%)
$15,000 (amount you need to make it all worthwhile)
$15,000 (target profit)
+$7,000 (your total costs)
$22,000 (revenue you need from running your business)
In this example, to cover the $7,000 costs per month of running your own business, plus the extra money you need to take the risk of ‘going it alone’, your revenue would need to be $22,000 per month.
Assuming a 40-hour week and, say, 12 hours of business development and administration per week (use your own estimates), the hourly rate would be figured as follows:
$22,000 (required revenue) divided by 28 chargeable hours per week (40 hour work week, less 12 hours administration and BD) x average 4 weeks per month
$196 charge rate per hour (plus GST if appropriate)
This is a simple example, but it gives you a sense of where to start. A good accountant and excellent record keeping are needed to keep on top of everything.
Value of personal time
Of course, you can do all the spreadsheet modeling you like, but if you have young children or other family obligations, the value of personal time is priceless. Whatever your fees are, you may find flexible hours, working from home and picking up the kids from school are more valuable than any dollar amount. People often willingly drop their income to gain this flexibility.
The choice is ultimately yours. It can be complex and competitive, but pricing is not a fixed item. Adopt a “test and learn approach” at different price points or during different seasons.