It does not matter if you or your accountant does your firm’s books, you must understand some financial and accounting principles. This topic should be an entire course so I will just summarize and point out some of the most important items.
Your business, in fact your life, depends on cash flow. That is incoming and outgoing money. You should set up a cash budget to help you establish your revenue needs. A cash budget usually is a set number of regular periods such as, monthly, where you list expected revenue and expenses. An electronic spreadsheet is perfect for this.
To become successful as a consultant, you need to educate yourself in the area of accounting and finance. There are a couple of reports that are very useful to examine the financial status of your business. These are an Income Statement and a Balance Sheet. You will complete an exercise where you complete one of each of these to become familiar with what information they provide.
How to determine your Consulting Fees
You must be able to justify the rate you charge to your customers, though probably you won’t have to do this verbally. Some people will view your fee as pure profit but obviously this is not the case. The consulting rate is a combination of three items: (1) the salary you pay yourself, (2) a portion used to pay your business’ financial obligations, (3) profit for the business. The combination of these is your billing rate per for a period of time (typically by the hour). The going rate for computer consultation in South Dakota runs from a low point of $25 to $115 per hour. Most local consultants charge about $60 per hour. Don’t let this cause dollars signs to fly into your head because it is extremely rare to bill 40 hours per week, there is considerable dead time due to lack of clients, seminars, preparation, just to name a few.
The first step is to estimate billing hours per week. Assume you will be working a 40-hour workweek for your consulting business from your home. Included in the 40 hours are at least 15 hours of prep work, marketing, ordering, and miscellaneous correspondence so you are left with 25 billable hours. This means that the most likely billable hours per year can be obtained by multiplying 25 by 50 (you will definitely need those two weeks of vacation) or 1250 hours. There are 2080 hours in a normal 40-hour per week, 52-week year. Most consultants end up with a 60% utilization rate. I know you think you can beat that rate and really get rich, and you might on the short run but over time it is a common rate.
The place to start is how much you want to earn as a consultant. Lets say that you are presently working at a job were you make $40,000 per year and you have decided to become a consultant full time. At the least you want to pay yourself what you were making before so let say the salary you pay yourself will be that. The most common method used to establish billing rates is the “rule of three” or the assumption that equal amounts should be allocated to Salary, Overhead, and Profit. Therefore, total revenue needs can be calculated by tripling your salary or $120,000. Now, that may seem like a lot of money but it is most likely correct. You can adjust the formula based on your unique situation. Lets say since you are working out of home, your overhead will be lower, which would in turn cause you to accept less than 40K profit, such as, $20,000 each. Then you arrive at a figure of $80,000. Either way you need to charge per hour the correct rate to achieve the desired financial goals.
Divide the $80,000 required revenue by the projected billable hours, (1250) yields an hourly billing rate of $64. You can see that if you needed a large office building and support staff then the initial figure of $120,000 divided by 1250 resulting in a consulting rate of $96 per hour supports the high end of the rate computer stores charge in the Sioux Falls area.
Your billing rate will be used to establish the amount you will bid on fixed contracts and estimates that you will need to provide to customers. Don’t agree on fixed contracts unless you are very sure of the time needed to complete the task. I have been burned several times when I agreed to a set contract to accomplish a task that I did not completely understand.
A combination of a fixed rate contract and your hourly rate is a better way to bid a fixed contract. That is, quote the client a rate of $40 per hour with an estimate of 40 hours then to ease your customer’s fears of running way over budget place a ceiling of 50 hours, or $2000 as your maximum cost.
Personal Financial Considerations
You don’t want to be in poorer financial shape as a consultant then you were as an employee, so you need to determine whether you can meet both your personal obligations (mortgage, car loans, utilities, etc.) and your business expenses. This may not matter to your business but now as an independent consultant, you and your business are the same entity.