How to Set Your Rates
It can be daunting to know how to set your prices when you don’t know where to start, but accurately determining your value is essential to your business’ success. There are many factors to take into account when setting your rates, but the overall formula is simple:
(hourly overhead expenses) + (hourly wage) + (profit) = (total price per hour)
This article explains, step by step, how to calculate your break-even analysis and how to use that information and more to set rates that are right for your business.
List Your Expenses
After you have created your business plan, make a chart of all your projected expenses, divided into startup and recurring expenses. For the purpose of setting your rates, you will want to focus on your recurring expenses. For example, if you run a shop you will need to pay rent and purchase inventory. If you do something dangerous you will probably have to pay for insurance. If you work with technology you may need to periodically upgrade your equipment. The chart below is a reference guide for the types of recurring expenses you may need to account for. However, your specific business model may have its its own set of needs that aren’t listed here.
- Salary of owner/manager
- All other salaries and wages
- Advertising/marketing costs
- Utilities, telephone
- Accounting fees
- Legal/Professional Fees
- Contingency/emergency fund
You will notice that one of the expenses listed above is your salary. You will want to set a salary that is realistic, attainable, and in line with the standards of your industry. There is a great deal of market research about average salaries for various industries available through government websites and market research firms. Some vocations have their own professional organizations which do market research within their own industry. When determining your salary, keep your own level of experience in mind. You will most likely not be able to pay yourself as much as someone with 10+ years experience if you are just starting out as a business owner. It’s realistic to expect financial hurdles when you start, especially during your first year. Don’t give up! Keep adjusting your prices and setting realistic expense projections and sales targets.
Keep in mind that you will need to spend some time working on business upkeep (such as organization, paperwork etc.) that you will not be able to bill for. Ideally, your salary should provide enough buffer to pay yourself for these hours. When billing a client, never pay yourself less than minimum wage!
Calculate Daily Operating Budget
Your next step is to calculate your daily operating budget. First, divide your annual expenses by 12 to see how much they amount to per month. Next, divide all your monthly expenses by the number of operating days you will be open for business in a typical month. Let’s assume you are open 5 days a week, 4 weeks per month (20 days total). You will divide your monthly expenses by 20 to get your daily overhead. Now you know how much you must earn in a day in order to cover your operating expenses. This is your break-even analysis. If you sell a small product and need to move a lot in a day to make a profit, you can break this even further down into an hourly total. For example, if you run a café, how many coffees would you need to sell each hour to break even?
Once you’ve figured out your break-even analysis you will have the absolute minimum you can charge in order to stay open, including a contingency budget and a reasonable pay rate for yourself.
You can use this formula to calculate your break-even analysis:
(total income) – (total expenses) = (minimum break-even sales requirements)
Do Market Research
Next, compare your prices to your competitors and other businesses offering a similar product or service in your area. Some industries have a very standardized and predictable price structure, others have a great deal of variation between the low and high end. If you find your rates are much lower than your competition, go back and re-examine your projections. Have you budgeted enough for supplies? Equipment? Contingency? Are your sales goals realistic and attainable? Is there a quality difference between your product and your competitors’?
You may find your prices to be higher than you would expect. Keep in mind that this amount is what your business is earning. After you have subtracted all of your supplies, maintenance, overhead, hours spent working on business upkeep activities, and all other expenses, what you have remaining is what you take home. You need to make sure all your business’ needs (and your personal ones) are met in order to keep performing your job and providing a quality product or service.