We all know money makes the world go around, but knowing how much to charge is one of the harder things to figure out when you start an agency or freelance business.
There are many methods (including just guessing), but after years of running my agency I’ve come up with a formula that works well.
1. How much does it cost to run your business? 📈
Tech businesses can have very low overheads in comparison to others, but it’s still important to know your running costs and to recalculate these every year or so.
For the sake of this exercise ignore salaries. Meaning don’t take into account what you pay yourself or your staff, as we’ll do that later.
I recommend creating a spreadsheet and adding every yearly expense - including items like new laptops and other once-off yearly expenses.
Here are some example costs you need to take into account.
- Rent (if applicable, or a portion of your home costs)
- Office costs (water, electricity, gas etc, or a portion of your home costs)
- Phone and internet costs (even if you’re working from home)
- Equipment (laptops, hardware etc, yearly average)
- Supplies (pens, paper, binders, floppy disks!)
- Accountant (tax preparation etc, yearly average)
- Insurance (professional liability insurance etc)
- Legal (contract preparation, reviewing etc)
- Professional development (mentors, coaches, courses, books etc)
- SaaS products (GSuite, HubSpot, LastPass etc.)
- Hosting costs (for your website if applicable)
- Advertising costs (Digital ads, physical ads, subscription services etc)
- Travel costs (for client meetings)
It’s handy to know your yearly forecasted running costs and your monthly forecasted running costs, as this helps you determine what you need to charge (at minimum) to cover your running costs.
With my agency, I kept a “current” and “expected” spreadsheet, as data changes year-by-year, and I know with my agency we were generally looking to hire, move office, or raise salaries. So knowing our current expenses and our forecasted future expenses helped us make financial decisions.
As an example, a small agency may have business running costs (without salaries) of $15,000 per year.
2. How much do you need to pay people 👩💻
This includes salaries and expenses to yourself, any full-time staff, and other staff (contractors and freelancers) that regularly help you deliver projects.
If on occasion you hire contractors to help you deliver specific projects, and you are confident that next year you will hire them for a minimum of X months - then include them in this cost. However, if you’re unsure then simply exclude them, and take their expenses into account on a per-project level (what you charge for each individual project) and not at a general hourly rate level.
Often new founders pay themselves “whatever is left over” which is fine. However, for the sake of this exercise, I encourage you to actively decide how much you want to earn per year, as that will help you determine what you need to get there.
As an example, a small agency with one owner and two full-time employees may pay $240,000 in salaries.
3. How much do you work per week? ⏳
This may seem like a silly question as everyone assume work is “5 days per week”, but more and more you see companies working 4 days per week or even a 9-day fortnight.
On top of this, the founders of new companies may be willing to work more to get things off the ground. So working 50 or even 60 hours per week is not unheard of (just try not to do it for very long!).
But it’s not just about how much you want to work, you also want to take into account public holidays, personal holidays, sick leave etc - and these figures differ depending on where you live.
But as an example, let’s say a small U.S based agency
- Works an average of 35 hours per week per employee
- Works an average of 47 weeks per year per employee
4. How much downtime do you have? 🤷♂️
Client service work can be famine and feast, and depending on your specific business you may have two months working at 60% capacity. Then three months of working at > 100% to deliver a large project on time.
Your goal is to get paid for that downtime - as that’s part of the game.
Aim for your famine times (when work is lean) to be covered by your feast times (when it’s in abundance), so it all evens out.
Having clients on ongoing retainers can really help with this calculation, as it makes everything more reliable if they lock in X amount of hours per week or per month.
As an example, a small agency in their first couple of years of starting may have an estimated downtime of 15% per year across all staff.
This means of the 47 weeks each employee works on average per year, they have 7 weeks of non-billable hours, or downtime when they are not actively on a project.
So where do our calculations get us? 🧮
Let’s recap on the example company I’ve mentioned so far.
This small U.S based agency has...
An annual business cost of $15,000, and an annual people cost of $240,000
So $250,000 - this is the figure we know that agency needs just to keep their business running and for everyone to get paid.
3 staff, who work 35 hours per week, 47 weeks of the year
So each staff member works around 1,645 hours per year or 4,935 hours across all 3 team members.
But remember we estimated a 15% downtime - meaning there is 15% of the hours in the year where the team is not doing billable hours. We need to factor this in, which comes to 4,194.75 hours per year across the team.
So the yearly costs of $250,000 divided by 4,194.75 (the yearly estimated hours taking into account 15% downtime) come to $59.59.
Meaning $60 per hour is the minimum hourly rate needed to cover costs, even taking downtime into account.
5. Awesome, so how much profit do you want? 🤑
In our example above, anything charged on top of that base $60 per hour will be profit for the business.
In general, a good profit margin for an agency is between 15% to 20%, but even as high as 30% plus.
So if $60 per hour is the break-even, then
- $69 per hour would see a 15% profit
- $72 per hour, 20% profit
- $78 per hour, 30% profit
- And so on…
Profit for your business isn’t all about swimming in a pool full of cash and buying fur coats, it’s about being strategic.
- Building up an emergency fund to handle any unexpected events (I recommend 3 months worth of business and salary costs saved up)
- Putting the profit back into the business to hire or staff, advertise more, or acquire other assets (like other businesses).
At the start of your agency, your profit margins will most likely be lower. But as you get more experienced, and build a larger network of clients - your profit margin can shoot up fast.
6. But how much do your competitors charge? 🤼♀️
It’s all very well working out how much you want to charge - but that doesn’t mean it’s how much you can charge.
The market will tell you if your rates are too high, as clients will go with your competitors. That is unless you offer awesome service that’s worth the price.
When working out your hourly rate, identity your competitors, and find out how much they charge. This is might be as simple as checking out their website, or looking them up on clutch.co. You might need to do some sneaky research. But generally hourly rates are not a secret, as my agency would be transparent about our rates in our first chat with a potential client.
If your rate is significantly higher than your competitors, you might want to either.
- Work on your value offering, so you really stand out - and make it clear to clients what they are getting for their extra dollars
- Reduce your rates
I would always recommend #1, but sometimes you may need to also reduce your rates whilst you figure this out.
7. How badly do you want the project? 🤞
Working out your minimum hourly rate is important. It helps you know your base costs and allows you to make informed decisions.
But an informed decision might mean not making much profit on a project because you see the business profiting - even if not a huge financial profit.
An example is one of the first large projects my agency took on. It was by far the biggest project we had won, but we knew we would only win it if we make less profit than normal (maybe close to 10%).
But for me, it was the right decision, as this client brought a lot more work in the future, and it was a high-profile project that was a great case study for attracting future clients.
Money can be a very emotional thing.
But by clearly calculating your minimum “break-even” costs, you can approach your rates more strategically.
You still need to accurately manage scope creep and choose the right pricing method that works for you. But knowing how much your business needs to cover the basics, and make a profit - that’s the first step.