You don’t need to be a mathematical whiz to calculate an accurate charge-out rate - this guide will take you through it step by step. However it’s important that you take the time to think about each step and go through it properly - the better your calculations are, the more accurate your charge-out rate will be.
What’s your target income?
Take into account the standard of living you’d like, what you might earn elsewhere, or what gains you might make from investment. For practical purposes, we’ll assume you’re setting up as a self-employed technical writer and you’re targeting an annual salary of $80,000 (this is just an example; the same principles apply whatever your business may be).
How many hours can you work per year?
If you worked 40 hours per week, 52 weeks a year, you’d work 2,080 hours. But of course you need to allow for holidays and sick days, plus all the hours you’ll spend on things you can’t charge for like administration, meetings, travelling, breaks etc.
As the table shows, a more realistic number of hours you can invoice clients for might be 1,350 hours.
You can tailor this calculation to your own situation, but don’t be tempted to skip on holidays as that’s a sure-fire way to burn yourself out. Also don’t underestimate the number of non-chargeable hours you’ll need to invest in admin, marketing and all the other aspects of running your business.
Total working hours in the year
4 weeks holiday
2 weeks statutory holidays
1 week sick days
Non chargeable hours (25% of time at work)
Divide your target income
Divide your target income by your chargeable hours
Now that you know how many hours you can realistically charge out for, you can work out what rate you’ll need to charge to cover your income.
Make sure you include the appropriate ACC levy for your line of work. To get an estimate of the ACC levy for your business, talk to your accountant or check the ACC website. For this example, let’s assume the levy is $1,500 per year.
If we add that to our target $80,000 income, that gives $81,500. Dividing that by 1,350 chargeable hours gives (rounded up) $61 an hour.
But that’s only covering your target income.
Adjust your rate to include overheads
Now you need to factor in your overheads. You should have a good idea of what these are from your business plan and cash flow forecasts. We’ll assume a figure of $50,000 for the year (power, rent, advertising, expenses, marketing, repairs etc).
$50,000 divided by your 1,350 hours means you need to add another $37.00 to your income charge - bringing your new hourly rate up to $98.00 per hour.
Add in a profit margin
So far, we’ve covered required income and overheads. Now we need to factor in a profit margin, otherwise the business won’t be able to grow. So if we assume a profit margin of 15% your final charge-out rate should be (rounded up): $112.70 per hour.
Compare your rate with the market
What you need to do now is work out how your rate compares to others in your industry – and whether it’s competitive or not.
If you are lower than the average market rates for your industry – you don’t have a problem, you have an opportunity. You can look at increasing your charge-out rate and improving your income. Or you could decide to charge less than your competitors to attract some of their customers.
If you are higher than the average – you may need to review your figures. Are they accurate and realistic? Are you aiming too high with your target income? Alternatively, you could look at emphasising the value-added components that justify a higher rate, such as guarantees, superior quality and customer experience.
Other things to think about
Working out how much money you need to bring in to stay in business is one thing. But it’s also important to know when it’s coming in, so you have enough to match the money that’s going out to pay for things like rent, utilities, and other expenses. If you don’t manage your cash flow your business can still fail, even if it’s trading profitability. For more on managing your cash flow you can check out our article on How to forecast your cash flow accurately, use our Cash flow forecast calculator or register for one of our practical workshops.
Your business plan:
A lot of the information you use to work out your charge-out rate (such as your overheads) should come from your business plan. A good business plan will also help you decide how much you can charge and whether your rate is realistic in your market. The better your plan, therefore, the more accurate your charge-out rate will be.
For help with developing an effective business plan, you can use our business planning template, for help with developing an effective business plan, you can read our step-by-step guide on how to write a simple business plan.
This material is provided as a complimentary service of ANZ Bank New Zealand Limited ("bank"). It is prepared based on information and sources the bank believes to be reliable. It is subject to change and is not a substitute for commercial judgement or professional advice, which should be sought prior to acting in reliance on it. To the extent permitted by law the bank disclaims liability or responsibility to any person for any direct or indirect loss or damage that may result from any act or omission by any person in relation to the material.
This material is for information purposes only. Its content is intended to be of a general nature, does not take into account your financial situation or goals, and is not a personalised financial adviser service under the Financial Advisers Act 2008. It is recommended you seek advice from a financial adviser which takes into account your individual circumstances before you acquire a financial product. If you wish to consult an ANZ Business Specialist, please contact us on 0800 269 249.