Step 1 in Smart Freelance Pricing?

This post is part of Free Money, the book about freelance pricing and money mindset I’m writing in public. You can read the Intro here and Chapter 1 here.

To see future installments as I publish them, get updates in my weekly newsletter and check out the Twitter thread I’ll be updating along the way.

Find your Survival Number.

When I was growing up, my family played Monopoly with a special rule. When one of us paid to get out of jail or after drawing a Chance or Community card, the money went into the pot, or “kitty,” in the middle of the board. Whoever landed on Free Parking got the whole kitty.

The rule brought surprising twists and unexpected endings. With one roll of the dice, you could go from the brink of bankruptcy to being flush with Monopoly money.

Freelancing is a game, but unlike Monopoly, it pays in cash and is a positive-sum game. Many people can win at the same time.

My family added the kitty to make Monopoly more fun—and honestly, easier for kids to win. If you’re not winning at freelancing right now, do what we did. Change the rules. Invent a new game.

“I just got a $500 per month raise. I usually write about 4 blog posts for them each month, and that was the deliverable I knew I was undercharging for. But, I look at the even bigger picture. They were my number 3 client last year in terms of billables. So, this represents a big difference when you look at it that way. It’s also a huge confidence boost for me. 😊 THANK YOU!”

What follows is a step by step process for setting your rates. Along the way, you’ll find your key numbers:

• Survival Number & Survival Rate
• Available Weeks
• Available Hours
• Time Inventory
• Effectiveness
• Minimum Hour Rate
• Dream Number & Dream Rate

You’ll also answer these questions:

• How many weeks of vacation do you want to take over the next year?
• How much other time off do you expect to take, including holidays, sick days, and personal days?
• Is your goal with freelancing to make extra money on the side or to earn more than enough to pay all your bills ?
• What did you make at your last full-time job? What was your salary or annual income after taxes?
• What minimum amount must you earn each month to pay your bills and not go into debt?
• How much does running your business cost each month?
• What ballpark percentage of your gross income do you pay in combined taxes each year—local, state, federal?
• How many hours do you work during a typical week?
• How many of those hours do you spend on client projects?

In “Hunted Down,” a detective story by Charles Dickens, the protagonist observes, “A very little key will open a very heavy door.”¹

Smart pricing is your very little key. The wrong rates can lead to disappointment and disillusionment. The right ones unlock the income you want. They bolster your confidence. They bankroll your desired lifestyle.

If you want that confidence to last, collect lasting principles and reliable rules of thumb. Here are three:

• Bank on variability of earning and the volatility of spending.
• Focus on controllables.
• Even if you’re a part-time freelancer, charge like a full-timer.

Account for variability of earning and the volatility of spending.

Imagine that your feet can grow and shrink independently. On a Saturday night, both feet fit a pair of glass slippers. The following morning, you notice that the the left foot stayed a Size 10 while the right foot tripled in size. Even NBA players would do a double take.

One shoe is your earning, and the other is your needs. Many factors affect both our income needs and our earning, and similar to bewitched feet, those factors stay in constant flux.

Our financial needs can change slowly and predictably. For example, a software engineer told me over lunch that he planned to propose to his girlfriend. When I asked what was stopping him, he replied, “It’ll take me six months to save for the ring.”

They can also change in an instant: “Dad’s in the hospital, and I need to buy a plane ticket now and fly home tonight.”

Changes may be temporary: “I want to earn and save extra for this bucket list trip to Iceland.”

Or they can be permanent, not to mention quite loud, hungry, and poopy: “We just had a baby.”

As a freelancer, you must account for both the variability of your earning and the volatility of your spending:

• You slack off on marketing, and your lead pipeline dries up.
• You go on paternity leave and work fewer hours.
• You take a short sabbatical to finish your book.
• You lose a long-term client when the company gets acquired.

No matter how diligent or disciplined we are, we will end up in situations we couldn’t anticipate. I once had a client I trusted “cancel” a project after I had finished it. Clearly, she didn’t plan on paying me the project balance, money that I was counting on.

Focus on controllables.

The only thing we can do is focus on controllables. One controllable is an up-to-date budget. As your immediate needs and long-term goals evolve, you’ll need revisit your monthly budget and freelance prices.

Do both the earning and needs shoes still fit? What adjustments will prevent face plants and blisters?

(Please note: Extended metaphors will continue until morale improves.)

Charge like a full-timer even if you’re not.

If you’re not dependent on freelancing, you really can charge less. Your full-time job pays your bills. Maybe you lean on a spouse or partner’s income too. The need to pay bills doesn’t drive your freelance pricing.

I still recommend that you go through these exercises as though you are a full-time freelancer who can’t afford a casual, cavalier attitude toward pricing.

Using your full income needs for the calcuations will benefit you three ways:

1. You may realize that your financial needs have changed and that you need to update your budget accordingly.
2. Should you decide to take the full-time freelance plunge, your rates will already be smart and sustainable.
3. Your higher prices will attract value-conscious clients and have more fulfilling relationships and projects. Pricing is positioning, after all.

Whether freelancing represents your entire livelihood or the occasional surplus, you stand only to gain by thinking and charging like a full-timer.

Now, for those enticing calculations.

Step 1 — Find your Survival Number.

Though I don’t think the principle is original to him, my friend Nick True at Mapped Out Money gives this advice: Widen the gap.

Whether you earned $1,000, $10,000, or $100,000 freelancing last year, the only way to avoid going into debt is to widen the gap between your spending and earning:

• Either you outearn your spending, or
• You underspend your earning.

It’s science, or at least common cents.

Even if you’re the rare person who rarely struggles to live within your means, take this opportunity to recalculate the minimum income you need each month to maintain or widen the gap between spending and earning.

1a. Estimate your average monthly personal expenses.

The easiest way to estimate your monthly personal expenses is to export bank and credit card statements for the last three months.

• Add up ninety days’ worth of transactions.
• Then, divide the 90-day total by three to get your up-to-date personal monthly budget.

You may be tempted to cull “unusual” expenses — for example, the $10,000 you spent on a Siberian tiger in Las Vegas. Best night of your life.

I recommend keeping all the expenses in your total with the exception of massive, highly irregular expenses, such as a down payment. There’s no such thing as a “normal” month of spending. Anew timing belt in your truck, antibiotics for that gnarly cat bite, the luchador mask you had to have for Halloween—unforeseen bills and purchases always show up.

“Budget” is just another word for plan. A sensible monthly spending plan has padding in the form of a “Stuff I Forgot To Budget For” line item.

1b. Add up your business-related spending.

Every freelance business has expenses and potential tax write-offs. To figure your cost of doing business for an average month, follow the same process with bank and credit card statements.

Those of you who already have dedicated business checking and savings accounts can follow these steps:

• Add up ninety days’ worth of transactions.
• Then, divide the 90-day total by three to get your up-to-date monthly total for operating expenses.

Those of you who don’t have dedicated business checking and savings accounts can revisit your personal statements, ideally, exported as a .csv file:

• Either, delete all the personal expenses, leaving only business expenses, or
• Create new spreadsheet using the list of business expenses below, then copy and paste business stuff mixed in with your personal expenses.

Once you’ve got the rough monthly total, add an extra line item for 10%. That padding will cover random, irregular expenses.

Non-Exhaustive List of Business Expenses

• Administrative (e.g., postage, bookkeeping fees)
• Office Supplies (e.g., printing, paper)
• Office Space / Overhead
• Internet Service
• Phone / Mobile Service
• Tools (e.g., laptop)
• Software & Subscriptions (e.g., email, web hosting, cloud storage, accounting software, time tracking, project management)
• Memberships (e.g., associations, industry groups)
• Education (e.g., books, courses)
• Travel / Conferences
• Local Licenses & Taxes
• Marketing
• Meals & Entertainment (e.g., coffee with clients)
• Education & Professional Development (e.g., books, business coaching)
• Professional Services (e.g., Tax Prep, Attorney Fees)

1c. Figure out your tax percentage.

How much did you pay in taxes last year? The number we’re after is the final percentage of your gross income.

Your percentage goes up or down based on lots of factors: your city, county, state, and country; your gross income, write-offs, and other tax credits and deductions; investments, assets, and other sources of income; and your legal entity structure, filing status, and overall tax strategy.

At the time of writing, Austria had a tax rate of 55%, the highest in the world. Bermuda, Monaco, the Bahamas, Andorra, and the United Arab Emirates (UAE) had no income tax at all.

Is your head hurting yet? Excellent. That means the real work has begun.

To find your tax percentage, you have three options:

1. Look at your last tax return. (Or, ask your accountant to tell you.)
2. Find two freelancers in your city with comparable income.
3. Make a conservative guess.

If you choose Option 1, here are the steps if you live in the U.S.:

• Find your gross freelance revenue — that is, all the money you earned as a freelancer in the last fiscal year. In the United States, you’ll find that number on Line 7 of Form 1040.
• Find the total amount of income and earnings you had after adjustments and deductions, such as allowable business expenses. In the U.S. the Internal Revenue Services (IRS) calls your taxable income “adjusted gross income “(AGI). You find your AGI on Line 11 on Form 1040, though don’t hold me to that. The IRS changes tax forms.
• Divide your taxable income by your gross revenue.
• Subtract that number from 1.0, and you’re left with your tax rate.

(If you don’t live in the U.S., run Google searches until you find the right set of steps for your country.)

For example, let’s say your gross freelance revenue was $50,000, and your adjusted gross income, or taxable income, was $40,000. Divide $40,000 by $50,000, and you get 0.8. Subtract 0.8 from 1.0, and you get .20. 20% is your tax rate. You should be proud to pay that. Thanks to your hard work, potholes on roads you will never use are being filled!

Options 2 and 3 both involve guessing:

• Ask a couple of local freelancers what their tax percentage was. Add their tax rates and divide by two.
• Or, pick either 25% or 30% and be done with it.

I recommend the latter. Don’t get bogged down with this step.

1d. Calculate your Survival Number.

You brave readers who have persisted this far now have three important numbers: your monthly personal expenses, business expenses, and tax rate.

We need one easy calculation to grab your Survival Number by the scruff of its skinny neck. Your Survival Number is the minimum you need to earn during a twelve-month period.

Here are the steps:

1. Subtract your tax rate percentage from 100. If your tax rate is 20%, then 100 minus 20 gives you 80. We’ll call that your Taxable Income Percentage, which was also the name of my first puppy.

2. Add up your personal and business expenses. This total represents your monthly “nut,” or the after-tax, take-home income you need to pay bills, set aside taxes, and not get into debt. Let’s say your personal expenses and business expenses add up to $3,000 a month.

3. Multiply that sum ($3,000) by 100. $3,000 times 100 equals $300,000.

4. Divide that number by your Taxable Income Percentage. $300,000 divided by 80 is $3,750. In order to take home $3,000 each month, you must earn $3,750. $750 of that goes to taxes.

5. Calculate your Survival Number for the year. $3,750 per month times 12 months equals $45,000.

Congratulations. You’ve have successfully completed the first grueling stage of the Free Money Math Gauntlet. You have your Survival Number. You really can’t make less than that, or you risk getting yourself into financial trouble.

“Wait, what if I live in a two-income household?”

Being in a two-income household usually means less pressure. Two breadwinners can split the bills. If that’s the case for you, you’ll take the dollar amount of your share of monthly personal expenses, along with your business expenses and taxes, and use it to calculate your Survival Rate.

Whether you’re flying solo or part of a two-income household, what you’re after is the right prices. The right prices will be exciting because they reward you for doing your best work. The right prices will be sustainable because they will cover your immediate needs and long-term goals. The right prices will be strategic because they signal value, expertise, and confidence and strengthen your positioning.

I’ll get into your Dream Rate later in the book, but for now, these questions will help you determine if you need to raise your prices:

• Am I getting the clients and projects I want?
• Am I getting the project outcomes I want?
• Is my work characterized by joy? Or am I tired or burning down?
• Do I feel good about making the amount of money I’m making for the amount of work I’m doing? Am I satisfied with what I’m making?
• Are we making progress on our long-term financial goals? Why or why not?
• Do I need to do anything to change my current situation or make it more sustainable?
• What would the next big win be?

Before we move on to Step 2, please enjoy a Business Dad Moment about dedicated business accounts.

Please open business checking and savings accounts yesterday.

Some freelancers have one checking account that looks like a kitchen junk drawer. Everything is jumbled together with rubber bands, batteries, and mysterious spare keys.

This messy approach creates confusion and friction. You don’t really know how much money you have. You end up spending money that doesn’t belong to you. (You may recall how I didn’t set aside money for quarterly tax payments.)

Do two things to remedy the situation:

• Open dedicated business checking and savings accounts. Accounting will be much easier, and you can likely get free accounts from an online business bank or local credit union.
• Read Profit First by Mike Michalowicz. Much overspending traces back to a lack of visibility. Mike’s envelope system for managing cash flow makes it easy for me to see how much money I have. Now, I don’t overpay myself.

Alright, Business Dad Moment over. See you in Chapter 2 where more punishments await. We’ll estimate your true availability for client work.

The Boring Disclaimer My Attorney Required

You’ll be shocked to know I’m not a financial expert, accountant, debt counselor, or lion tamer. I lack the qualifications to give financial or tax advice, so I don’t give financial advice. Everything you find in this book is for informational purposes only. I cannot tell you how to invest your money, pay off your debt, or execute a double fiscal somersault. Please consult with a tax professional, and while you’re at it, ask her to explain the difference between tax avoidance and tax evasion.