I was asked the other day to explain in one minute or less how independent consultants determine their daily rate. Okay! The long story short is actually a formula:

Daily Rate = (Salary + Overhead) / Billable days + Profit

But if you are like me, Algebra was a long time ago, so perhaps a longer short story will be more meaningful.

iStock 000011516022XSmall scissors  measuring tapeThere are four important facts you must know to determine your daily rate. To get to that bottom line, some reflection and a few calculations are in order. You need to know the following:

    1. The total amount of time in a year you have for
        client work—billable time.

    2. The cost of running your business for a year—overhead.

    3. The amount of money you want to make in a year—salary.

    4. Your profit margin or, you’ve got it—profit!

 Here is a quick overview of each.

1. Billable time

A dose of realism will help us get started. Just because there are 365 days in a year, don’t assume that you will be doing client work on all of them. To maintain some work-life balance, you will need your weekends to yourself so your starting point is actually 260 working days (i.e., 5 days x 52 weeks). Then there are statutory holidays (2 weeks); why should you work if no one else is? To avoid burnout, you also need an annual vacation (4 weeks). Sooner or later you are bound to get sick (1 week is all you get so take your vitamins). Now you are looking at 225 working days.

But wait—how much time do you need for all those necessary but unpaid tasks to keep your business humming along? Over the course of a year you could easily use 10 weeks for startup activities and on-going marketing (approximately 25% of your time), 4 weeks for administration and management (approximately 10% of your time), and one week to keep your skills sharp by reading articles, participating in webinars, or going to a conference. What you have left is 30 weeks or 150 days for client work.
This is your billable time.

2. Overhead

What is it going to cost to run your business? A good way to make some hard decisions when you start your consulting business is to look at operating costs. The clearer your vision and the better thought out your choices, the less your overhead will be, so it is worth the number crunching to calculate both start-up and on-going business costs.

Determining whether you choose a home office or rented space is one of the biggest decisions you will make that affects your overhead. Other big-ticket items include:

    • Equipment and furniture,
    • Insurance (life, general liability, theft, automobile, professional liability, and health if in the U.S.),
    • Salaries or wages and benefits for staff if you hire any (but don’t count yours here),
    • Communications (land line/cell, fax, internet),
    • Web site development, and
    • Taxes.

Estimate these and other monthly and annual operating costs using a spreadsheet program. The total is your overhead for the year.

3. Salary

You should treat your consulting practice like any other job and so you will need to pay yourself a reasonable and regular income. If you are just starting out, however, you may not know what “reasonable” is. Ask yourself what you need for both your personal and family expenses. Your partner’s support in this endeavor is critical and so this is a good time to have a heart-to-heart discussion. How badly do you want this career choice? What sacrifices are you both willing to make? What is your bottom line in terms of needed income?

If you still can’t come up with an annual figure, start with your previous base salary. You should make at least as much as you did in your last job, or why are you doing this? You can also check online for average salaries and pay scales for consultants and evaluators, but they vary widely by industry, level of experience, and employer. For now, determine a reasonable and realistic salary for your first year in business.

4. Profit

Because your salary is part of the formula, you may think that profit is not essential but think again. The truth is that profitable businesses make a profit. You deserve at least a small reward for your risk, effort, and investment. You also need to save for a rainy day. Typically a profit margin of 10-15% is a good place to start. If you make a profit in your first year, celebrate your success; if you don’t, find out what went wrong and make some changes.

5. Your Daily Rate

Armed with this financial information, you are now ready to figure out your daily rate:

Step 1              Salary + Overhead = Total costs/year

Step 2              Total costs divided by Number of billable days = Daily base rate

Step 3              Add a profit of 10-15% and round off the total. This number = Your daily rate

You can also divide your daily rate by 8 hours (or the number of hours in your work day) to determine your hourly rate.

If you don’t like the answer you get, go back to the drawing board and review your assumptions. Change your billable days, desired salary, profit margin, or overhead—play with the formula until you come up with a figure that works for you. Once you know what you need to charge to stay afloat, you can prepare realistic proposals and can enter the marketplace with confidence.

Next up: Tracking your time

For more examples and worksheets to help you calculate your fees, see Chapter 8: Setting your Fees and Appendices 2 to 5 in my new book:

Barrington, G. V. (2012). Consulting Start-up and Management: A Guide for Evaluators and Applied Researchers. Los Angeles: SAGE.

Photo: iStock