Two weeks ago, I shared my list of all the non-client work I do each week, explaining that some of the most important work I do every single week can never be billed. If you missed that, you can find it here.
In that post, I promised that this week, I’d talk about the three metrics I use to make really, really, super sure that I make a profit with just about everything I do.
I’m a sole proprietor, which means that technically all of my business income is pass-through income. Despite that, I keep all of my business finances separate (it makes bookkeeping SO. MUCH. EASIER.) and instead pay myself a regular bi-weekly “salary.”
My family counts on it. Without it, I can’t pay for daycare, I can’t pay the mortgage, I can’t buy groceries.
Ensuring that I’m always making a profit is crucial.
Ensuring that I’m always making enough on client work to pay for all the non-client work I mentioned last week is crucial.
Here’s how I do it.
First, I always make sure I’m keeping track of three metrics:
- How I spend my time. (I’m a total time tracking convert-slash-evangelist. I use Toggl because I can use it on all my devices and I can edit the times for each task so that if I forget to start the timer, I can easily start it now and then change the start time to whenever I actually started. It also has awesome tagging, project, and client features.)
- My expenses. I’ll include a somewhat comprehensive list below.
- My “capacity.” This is determined both by how many hours I can/want to work in a week and how many client projects I can actually (successfully) take on in a week.
Then, I use these three metrics to figure out my hourly rate. (Even if you don’t charge hourly, and even if you sell physical products, you need to figure out your hourly rate.)
(In an upcoming post, I’ll go into how I use my time tracking along with my hourly rate and capacity in order to set and adjust project pricing. I’d love to know if you’d rather have that Memo next week, or if you’d like a little time between math-related Memos to digest and unwind. Let me know in the comments.)
To calculate my hourly rate (something I do periodically to be sure it’s still an accurate reflection of those three metrics above), I start with metric one (how I spend my time).
I use my time tracking data to determine how much of my time is “billable” (a.k.a. how many hours I’m working directly with paid clients or on already-paid-for work) and how much of my time is unbillable. It’s extremely helpful here to have a month’s worth of data or so, since the business life of a creative entrepreneur tends to be irregular and since I like to have a pretty accurate average. Once I look through the data, I can come up with an average number of billable hours per week. We’ll call this my Actual Billable Hours.
Next, I need to factor in my work capacity (metric three).
When I’m working at “capacity” — meaning I have exactly as much work as I want and can handle each week — then I just take my Actual Billable Hours as calculated from my time tracking data and I use that as my At-Capacity Billable Hours in the rate calculations below.
When I am working over capacity (and I know I need to cut back) or when I am working below capacity (and I would like to have more work and think it is likely that I will get more work in the coming months), then I need to use my Actual Billable Hours from above to estimate how many billable hours I would be working each week if I were working exactly at capacity (again I’m calling this my At-Capacity Billable Hours).
Here’s an example:
If you’re currently working 20 hours a week and 6 of those are billable, and your capacity is 36 hours a week, then your billable hours (assuming you can bill the same percentage of your hours, which we might as well assume for now since its the conservative way to go) would be 10.8/week. (I figured this out like so: current billable hours divided by current total hours times desired capacity or 6/20*36=10.8.)
So that gets me my At-Capacity Billable Hours. I hang onto that number because I’ll use it again later.
Once I have a decent handle on just how much of my time is actually billable (on average) in a given week, I gather my expenses. I always make sure I’m covering my expenses at three main levels: business expenses, self-employment expenses, and cost-of-living expenses.
Those break down as follows (I tried to make these lists fairly detailed, but they’re probably not complete. This is why it’s good to work with your own bookkeeping records.):
BUSINESS EXPENSES: (this is where you need your detailed bookkeeping info)
- office rent
- software/subscription services
- utilities (internet, phone, etc.)
- web hosting
- business or studio insurance if needed
- accounting/bookkeeping fees
- office supplies
- advertising/promotion costs
- other expenses
- sales taxes owed (on average)
- retirement contributions
- state and federal taxes
- any business loan payments you might have
- rent/mortgage, student loans, etc.
- food, drinks, entertainment
- medical expenses, car repairs, home repairs, etc.
- gift giving, etc.
(If you share financial responsibilities with someone else, like a roommate or spouse, only include your portion here.)
Basically, I add ALL those numbers up into one big Total Expense number. This is the minimum required income I need to make each month or year (later you’ll need the yearly total so you can figure that out here or do the monthly here and multiple by 12 to get the annual total) in order to live without new business or personal debt. This is a super important number. I know mine like I know my phone number.
Finally, I can figure out my minimum hourly rate. I need to use the following:
My At-Capacity Billable Hours (A quick note here: if I’m currently working below capacity and hope to get more work in the coming months, but it’s kind of a gamble whether I will, I like to run an hourly rate based on my current situation and then again based on my desired situation and settle somewhere in between). Let’s use the example above and say my At-Capacity Billable Hours is 10.8 hours/week.
Number of weeks I’ll work this year (I always factor in vacation weeks, personal time, sick time, holidays, and occasional school closings that don’t have coverage at daycare). I typically work 48 weeks out of the year.
Next: I multiply those two numbers to find out how many billable hours I can expect to work in a year. When in doubt, I’m always conservative. Using our running example, I would multiply 10.8 times 48 and get 518 billable hours per year. I’m calling this my Annual Billable Hours.
Next, I bring back my Total Expense number from before — the sum of all my business, self-employment, and cost-of-living expenses. Let’s say my total is $43,440 (I don’t know why I didn’t just pick a nice round number. Go with it.)
Here’s where the magic happens.
I take my annual Total Expense and divide it by my Annual Billable Hours. In this case, we’re taking $43,440/518 and getting an Hourly Rate of $84.
That number tells me that if I can bill 10.8 hours every week at $84 per hour, I can exist, covering ALL those expenses I noted above and paying for all other non-billable hours that week, without any new business or personal debt. (It also tells me that if I’m not billing 10.8 hours per week regularly, I need to put a little more hustle in my routine.)
Since I don’t bill hourly, I multiply this out to figure out my minimum required income each week in order to break even (10.8*84 means I need to be making about $910/week).
One last note: In the example above, I didn’t add in a cushion or any kind of savings. I do usually add those in after I calculate my base. To do so, I just add them to my Total Expense number before dividing by my Annual Billable Hours. Adding in a goal of saving $10,000 this year would change the calculation as follows: $53,440/518=hourly rate of $103.
So there you go. My Extremely-Critical-To-Know hourly rate. Once you’ve got yours, write it on a piece of paper and post it next yo your computer.
But How Do I Use It?
Now, unless you strictly bill hourly, which most people I know don’t, just knowing your hourly rate isn’t really enough to make super damned sure you’re always making a profit. You also need to know how to turn your hourly rate into a project price, and you need to always be monitoring how close you are to working at your capacity, bringing in your minimum required profit, etc.
I thought about going into all of that in this week’s Memo, but in the end it just seemed overwhelming. So as I said before, I’m going to save that for a future Memo.
So before I go I want to ask you two things, and I would love to hear your responses. Leave a comment below with your answers to the following two questions:
First: should I do the project-pricing post next week, or do you need a little break from Math before we delve into that in detail?
Second: I used to have a favorite online calculator for figuring out my hourly rate using all the info I just described, but it’s gone now. Would you like it if I created one to share? Would you want it to be an online form? Or a spreadsheet? Or more of a workbook?