A very common question among service providers is: “How much should I charge per hour?” Or per day? or per whichever unit they sell their services for.
Evidently, I don’t know you or your business, so I can’t answer that directly. However, I can tell you what you need to calculate to determine the absolute lowest price that you can charge if you want to run a sustainable, profitable business, since that one can be determined through cost-based pricing.
Now. Why do I say that I can’t say what your ideal price is, but that your service’s absolute minimum price can be calculated?
Because I believe that a product or service’s ideal price can only be determined through value-based pricing.
In case you’re not familiar with the term, that is a pricing method that consists of setting a price that’s aligned with what the market is willing to pay based on the value that the product or service is perceived to create for the buyer.
Unfortunately, your value-based price isn’t something that I can give you a formula or a spreadsheet to calculate. Assessing it requires market research, analysis, and it must be a part of a wider strategy.
If you want to have an idea of how to gauge for willingness to pay, you can check out the post about the 5 questions you must ask potential clients to assess willingness to pay.
However, regardless of the pricing method that you choose to implement, be it cost-plus pricing, competitor-based pricing, or value-based pricing, there is one condition that must always be ensured if you want to build a sustainable business: your price must at least cover all your costs.
And that’s what we’ll be calculating today. The price that you’d need to charge to be able to at least cover your costs, your salary included. And we’ll be calling that price your break-even selling price, or absolute minimum selling price. It’s your floor price. Below this value, your business isn’t sustainable.
And even though I’m a big proponent of value-based pricing, I do believe that it’s important to start your pricing analysis by calculating the absolute minimum that you must charge to be able to break even.
Because your value-based price must be higher than your breakeven price. If that’s not the case, you’re in big trouble.
Anyway… it’s not uncommon for people to unknowingly charge prices that don’t even cover their costs. This happens for two reasons:
- It’s easy to underestimate the costs of running a business, and
- It’s easy to overestimate the amount of time you can spend working for clients.
So, this minimum viable cost-based price analysis should be done by anyone selling his or her time, to make sure that they don’t make any (or both) of these two mistakes.
Moving on to how to actually do it, to calculate your breakeven price for your services, you need to:
- Calculate how much it costs you to keep your business running (it’s probably way more than you think),
- Calculate how many billable hours you can work (which are probably way fewer than you think).
Remember that not all the time you spend working on your business can be billed to clients.
Let’s then start your calculation of your minimum service rates by listing all your costs.
But before we start, make sure that you are using the same time period for all your costs. That is, either keep all the costs on a monthly basis, therefore dividing your annual invoices by 12, or, keep them all on an annual basis, therefore multiplying your average monthly invoices by 12.
Otherwise you’ll have a mishmash of periodicities and can’t add the numbers up to get to a total average cost per whichever period of time you prefer to work with.
Also, keep in mind that you need to work with estimates of future costs, since the point here is to set prices going forward.
That means that your numbers won’t be accurate; you need to use rough estimates of average costs. And it’s ok to use rough estimates; there’s no other way to do any sort of business planning, what’s not ok is to forget significant cost items.
There’s always a risk of that happening though, as there’s a risk of having unexpected costs that you need to cover, so when trying to estimate future costs, it’s usually a good idea to add safety buffers.
You need to make sure that even if you forget something significant, or if any unexpected cost comes up, you don’t get into trouble because you underestimated your costs, and are therefore working with crappy data to try to assess whether a given price is profitable.
And now to our list of costs, in no particular order:
Cost group #1: Employee compensation
Ok, so this is an obvious one.
Whether you work by yourself or have employees, it's hard to forget that you have salaries to pay. But do make sure that you include all other benefits, insurances, and employer taxes, since you have to pay for those too.
Regarding your personal salary and related costs, I would suggest keeping them on a separate line form all the other employee costs, so that you can later build scenarios with different salary levels.
For example, you may want to know how much you’d need to charge to get to you minimum “I need this to survive” salary, to your target salary, or to a dream salary.
Remember that you can also build compensation scenarios through adding different profit margins on top of this minimum price that we’re trying to figure out here, so don’t overcomplicate this.
Just a quick note here: you probably will have tax motivations to select between being compensated mostly though salary or through profits, but that’s specific to both where your business is located and where you live, and not something I can help you figuring out. You would need to talk to a local accountant.
And if you’re new to this, it would be a good idea to talk to an accountant in any case, because you need to make sure that you understand what taxes you’ll need to pay. Never play around with taxes. And make sure they get paid.
But let’s move on to...
Cost group #2: Office and supplies
The fact that you need to pay rent (unless you work from home) also makes it an obvious cost. But there's a lot more to "office space" than meets the eye.
Offices need furniture, utilities, telephone and internet, fire safety plans, equipment (at least computers and printers, besides anything else you may need), maintenance services, cleaning (did you remember cleaning?), insurance, office supplies (did you consider that the printer needs toner and paper?), etc., etc., etc.
So, make a list of everything that your business needs in terms of office equipment and supplies.
Note that if you work from home, you should include only those things that you wouldn’t otherwise need to buy anyway.
We want to analyze the costs that are generated by your business. So, even if you include some household expenses as business expenses in your taxes, this analysis isn’t the place to be doing that.
We want a clean set of data so that we know how much you must make to cover your real costs of doing business. You would have to pay for those expenses regardless, so therefore they are irrelevant for this analysis.
And it’s time to move on to...
Cost group #3: External service providers
Under this category we would list your accountant, lawyers, virtual assistants, web designers, developers, consultants, coaches, and any other people that you need to hire to perform tasks that aren't performed either yourself, or by someone else on your payroll.
These are people who don’t really work for you; they provide services to your business, but send you an invoice; they’re not your employees.
Cost group #4: IT costs (that includes software, hosting, etc.)
This is one of those things that can easily add up these days. Companies selling software as services seem to be sprouting like mushrooms, so if one isn't careful, by spending $10 here, $20 there, $30 over there... IT costs can get out of hand, even if individually all the cost items seem small. So, make sure to list all the software tools that you are using.
Don't forget your hosting, email providers, scheduling tools, image and/or video editing tools, website and landing page builders’ licenses, plugins, etc., etc., etc.
And then, we have...
Cost group #5: Marketing
Ok, this one is self-explanatory. Don't forget your marketing budget, no matter how small.
And if you prefer to include for example your social media scheduler here instead of with other software costs, that’s fine. For this analysis it doesn’t matter under which category we include which costs.
This is just for us internally, so put things where they make sense to you, and where you're less likely to foget them. Just make sure that you are thorough when making the list of everything that you need to spend money on to keep the business going.
But anyway, after this tangent, let’s move on to...
Cost group #6: Knowledge development & certifications
To do your job you need to stay updated. It may be easy to remember the mandatory certifications that you absolutely must have to work in your field, but to stay competitive you need a lot more than that.
Don't forget to list all the publications, trainings, databases, reports, industry associations' quotas, and all other knowledge development tools and activities that you will need to invest in to be able to deliver your desired level of quality.
Being the best (or at least good) requires constant improvement. And that costs time and money. So, list it.
And speaking of time…
As I mentioned in the beginning, not all the time you spend working on your business can be billed to clients.
Time you spend on trainings, planning, on admin work, on marketing activities, on business development activities, engaging with potential clients, writing business proposals, hopping on discovery calls or answering potential clients’ questions… or on whichever activities that your business requires that aren’t directly related to serving the client… ALL that time that you invest on:
- Running the business
- Being able to make a sale
well… you can’t actually charge for.
So, you need to take into account that:
- You don’t work 365 days per year. There are weekends, holidays, you get sick, and… you need time off every now and then.
- Even the time that you do spend working, can’t all be spent on activities that you can charge for.
Therefore, the next step in calculating the minimum you can charge per hour or per day to break-even, consists of estimating (or ideally tracking) how much time you spend on billable vs. non-billable work activities.
And you need to do this for your team too (if you have one). You need to figure out the total amount of billable hours that you can sell to clients per month or year (or per whichever time period you selected to calculate your total costs for).
You can only charge for time you spend working for clients. So, to figure out your absolute minimum price per hour, you need to divide your total costs by total billable hours only, and not by total hours worked.
After you do all these calculations, remember that the number that you get out of this, is what you would need to charge per time unit (day, hour… whichever one you chose) just to cover your costs, including those of the salary you included for yourself.
So, at these prices, your business wouldn’t even make a profit. It would pay your salary, but not make an additional profit on top.
And an important side-note here: this analysis does not take into consideration your ability to charge these prices, so it does not mean that the price that we get from this exercise is a good price for your services.
However, it does mean that:
- You need to be able to charge at least that price if you want to break even at the salary level that you included for yourself.
And, if you find out that that’s not possible for you right now,
- You need to cut some costs, and/or do some work in terms of value selling your services.
And if you need help with value-selling your services, my next post will be on how to deal with the “you’re too expensive!” complaint. I will publish a 4-step strategy to better communicate your services' value before I go back to my “How to do market research for a new product or business” series that I had just started.
Anyway, I hope you found the post helpful, and to see you in the next one! Bye!