The essential way to set your fees: a step-by-step guide to calculating what you must charge - marketing your services

Home Office Computing, Oct, 1991 by Daniel P. Dern

A Step-by-Step Guide to

Calculating Whay You

Must Charge

Of the many skills needed to stay in business, knowing how to set fees for your services is one key to successful marketing. Yet the underlying methods and issues on setting fees are too often unfamiliar to service providers, consultants, and other entrepreneurs.

Pricing plays a central role in how much (or little) you earn for the work you do, and in the psychological subtleties of your business relationships. Set prices too high, and you may lose valuable business. Lowering prices may garner you assignments and projects you'd otherwise miss. But too-low prices can also translate to working unnecessarily long hours, to earning less than you should for your efforts, and, in the worst case, to earning less than you need to turn a profit.

FUNDAMENTAL STRATEGIES

There are several strategies you can use to set fees, ranging from asking for the going rates to raising your rates until clients say ouch. But the bottom line is cost-based prices--that is, fees that reflect what it costs you to be, and stay, in business. (You still may decide to negotiate different rates at times.)

Cost-based prices are relatively easy to determine. It will take you some thinking, perhaps a few phone calls, and then a little time with your spreadsheet or caculator. It's an exercise all serious businesspeople must do, once or twice a year, even if they also set prices by other methods.

In return, you get real, bottom-line information essential to both starting and running your business. This article offers a step-by-step guide to basic fee-setting data, plus a simple way to get a rough estimate. The process applies to any business that sells time and knowledge.

There's nothing mysterious about the process I describe here. You'll find it in almost every book of self-employment and consulting. Yet a surprising number of self-employed individuals and small businesses I've talked with have never done this exercise.

CALCULATING COSTS

Too often, people underestimate the full costs of starting up and maintaining a business, even if it's something as simple as doing transcriptions using a computer.

Just like the real cost of running a car includes not only the purchase price, but also insurance, maintenance, repairs, gas, parking, tolls, auto-club membership, and an occasional car wash, running a business entails ongoing spending for recurring costs and fresh investments in equipment.

Costs fall into three categories:

1. Business and office expenses. You can start up a business on a shoestring--with only an answering machine and business cards, to be precise--but it's hard to run one for long on that basis.

Day-to-day expenses are part of the cost of being in business. Your pricing must reflect these costs--that's one reason that the rate you charge is different from what a full-time employee appears to be paid.

With few exceptions, you'll need to run some kind of office, even if it's a room where you live. You'll have ongoing expenses, such as phone and electric bills, postage, copying, stationery and office supplies, and subscriptions.

Also, you'll need to make regular investments in office equipment and furniture: computer purchases and upgrades, filing cabinets, fax machine, copier, desk, telephone headsets, and more. And you'll quite possibly have business-related taxes, such as sales tax and service tax.

Excluding rent on office space, many home-based independents report that phone bills are their biggest expense, followed by major equipment purchases, like a new laser printer or a plain-paper fax machine. It's also easy for memberships and subscriptions to add up to $1,000 a year.

One piece of good news: As a rule, business expenses come out of pretaxable dollars, subtracted on your Schedule C from your gross revenues to yield your taxable net income.

2. Salary and personal taxes. One rule of thumb for self-employment says you should plan to earn about what you'd get as a full-time employee--otherwise, being an employee may be a simpler way to pay your bills. Lower stress and higher satisfaction are important benefits of being self-employed, but economic issues must often come first.

Another way to start setting your fees is to determine what "salary" you need, in annual, monthly, or weekly terms. Don't forget to consider personal taxes in your calculations. Underestimating or miscalculating the money due to the government out of each "paycheck" is a common pitfall.

As a Massachusetts resident, I pay state income tax in addition to federal income tax and social security. According to a graph I did recently, the total tax bite on my income runs about 40 percent. In other words, for every $1,000 I want for take-home pay and benefits, I need to earn about $1,600.

The prudent person will open a separate bank account, designated for Our Friend the Tax Collector, and put the appropriate percentage of each received check in it--so it's there when payment times roll around, and earns interest until then.