One of the toughest things new contractors encounter is deciding on an hourly rate. They don't want to aim too high and miss out on jobs, and they don't want to go too low and end up worse off than the permanent job they just left.

## The rate formula

My advice is to apply a simple formula to determine your asking rate. The formula takes into account the following factors:

- 28 days (4 weeks) annual leave (proper holiday leave, not just gaps between contracts)
- 11 days public holidays (check your state's official public holiday list to verify this number)
- 10 days sick leave (yes, even if you “never get sick”)
- 14 days equivalent training leave and expenses (so you can afford books, maybe a course, and time off to attend)
- 5 days long service leave

There are some other factors to consider as well that I'll go into in a moment.

Based on a 40 hour working week a full time employee is paid a salary for 2080 hours per year (40h x 52w), some of which falls into the above categories. So for a contractor who only gets paid for the hours they work, and none of the hours for days like those listed above, they need to charge a higher hourly rate than the permanent employee. If you subtract 544 hours (68 days x 8 hours per day) from that you get 1536 hours.

This makes 1536 hours a simple basis for calculating an hourly contract rate. Lets take a look at a few examples using base salaries (ie excluding superannuation):

- $35000pa is about $17/hr for a permanent employee (35000/2080). To earn $35000 as a contractor you'd need to charge about $23/hr (35000/1536).
- $50000pa is about $24/hr for a permanent employee, and about $32/hr for a contractor.
- $75000pa is about $36/hr for a permanent employee, and about $49/hr for a contractor.
- $100000pa is about $48/hr for a permanent employee, and about $65/hr for a contractor.

The calculations above give you some indication of why contractors can be earning much higher hourly rates yet still be on an equivalent annual salary to a permanent employee making less per hour. This is why its important as a new contractor not to be dazzled by what appear to be high rates that may actually leave you worse off.

## What else to consider

In addition to the factors listed above there are other considerations when calculating your hourly rate, such as:

- recruiter's commissions
- superannuation
- insurances
- GST
- other costs associated with operating your own company
- unplanned breaks between contracts
- tools and equipment

Each of these will depend on which method of contracting you're utilising, and the duration of each of your contracts. If you're using a recruiter then you can take the simple approach of asking for a base rate and tell them to work out super, commissions, and other fees for services they provide such as insurance on top of that. In other words you're telling them “This is how much I want for myself, you work out the rest”.

### Don't forget company overheads

If you're operating your own company you need to also account for GST, the cost of registering and maintaining the company each year, your own insurance policies, your mobile phone, and tools and other equipment such as a laptop (and don't forget software!). Your accountant can work this out for you and then you can calculate it in terms of an equivalent number of days/hours. So for example you may find that your company costs are the equivalent of 10 days pay, so you would deduct another 40 hours off the 1536 hours when calculating your hourly rate.

### Not all of your “holidays” will be planned

Finally you need to consider the possibility of unplanned breaks between contracts. This will depend on the job market at the time, your network of contacts that help you land jobs, and the level of demand for your particular skills. Remember you are allowing for potential problems in the future, so plan for the bad times not the good times. You might take an approach such as allowing for 2 weeks between each contract. This would mean:

- 12 month contract, allow 2 weeks
- 6 month contract, allow 4 weeks
- 3 month contract, allow 8 weeks

Applying the 6 month rule as an example you would take 160 hours off the 1536 used for calculating your hourly rate.

## Two examples of how to apply the formula

All of that may seem confusing, so here is are two examples:

Bob wants to leave permanent employment and try contracting. He earns $60000 + super, and he decides to use a recruiter's contract management services. The recruiter wants to know Bob's asking rate, and what length contracts he is interested in. Bob decides 6 month contracts would be ideal.

1536 hours – 160 hours = 1376 hours.

$60000 / 1376 = $44/hr + super.

Mark wants to leave permanent employment and try contracting and freelancing. He earns $80000pa + super, and works with his accountant to set up a new company for him. ASIC fees, accountant fees, insurance and other business costs work out to around $5000 per year. Mark is also allowing for short contracts and the risk of infrequent freelance work. He decides to use 1000 hours as the basis for his rate calculations.

$80000 / 1000 = $80 (ex GST).

When deciding on a contracting rate it is important to know your skills, know the job market, and have a proper appreciation for the difference between a permanent hourly rate and a contract hourly rate.

In the next part of this series I'll discuss how to find work as an IT contractor.

Dave says

I recommend a much simpler approach – though broadly similar.

Take your current annual salary.

Double it. This cover the unpaid holidays, time off, pension contributions, employer tax etc. (UK based)

Divide by 40 to give your weekly rate.

Divide by 5 to give your daily rate (many contract positions now quote a daily rate).

Divide by 8 or 7.5 to give an hourly rate as appropriate.

Divide by

Bob says

Another simple approach is to divide your annual salary by 1000, which will give you the hourly rate.

E.g. salary $75000pa -> $75/hour

Randy Savage says

Or better yet, Divide your previous salary by infinity…

Andy says

The method described doesn’t take into account profit margin. You’re running a business and taking a risk, so you should make a profit to compensate you for that risk. It’s ‘money for a rainy day’. The risks are quite significant: what if you go long term sick?; what if you’re a victim of bad debt?; what if there’s a recession or market downturn? A reasonable profit margin is 20%.

Let’s say your salary is $80,000 / year, your overheads are $5000 / year, and you’re budgeting for 1500 billable hours / year. Therefore your total costs / billable hour are ($80,000 + $5,000) / 1500 = $56.67 / hour. Add on 20% profit and you get $56.67 x 1.2 = $68 / hour. You can round this up to the nearest $5 so therefore your hourly rate works out at $70 / hour.

Paul Cunningham says

Did you read the whole blog post? It’s got a whole bit about overheads and unplanned breaks. And then your $80000 example has come out to a lower rate than mine.

Andy says

Yes Paul I note your point but my calculation as displayed was just an example where I happened to use 1500 billable hours / year as the budget. If I’d used 1000 hours my rate would have worked out at $100 / hr.

Paul Cunningham says

I’m still not seeing your point. If $100/hr is what you worked out for your circumstances then that’s fine.

Andrew says

Hi Paul. Firstly, sorry to be extremely late in replying. I didn’t come back to your site after my last post, until now! The point I was making is nothing to do with overheads or unplanned breaks. The point is that you’re running a business and you can’t sensibly run a business on a ‘break even’ business plan. You should be running a business with a plan to make a profit (or mark up) and all successful businesses do that. Why should contractors be any different? You need a profit to provide you with ‘money for a rainy day’ i.e. to prepare yourself for unexpected costs and other risks. Another reason is that some contractors / consultants may wish to invest in growing their business.

As an example:

Required salary = 80,000 / year

Other costs/overheads = 20,000 / year

Therefore total costs = 100,000

Profit (mark up) at 20% = 20,000

Therefore target / budget sales revenue = 120,000

Budget number of billable days / year = 150

Therefore budget daily rate = 120,000 / 150 = 800 / day

If the daily rate is very briefly explained to potential clients in the manner above, then in my experience most of them will be satisfied that you’ve priced yourself professionally and REASONABLY and will be quite happy with your rate. Furthermore your cheaper competitors may well be suddenly perceived as being too cheap to be any good!