The Freelancer s Finances

The Freelancer's Finances

In any business, the ultimate key to success lies in making sensible financial decisions. For freelancers, this means selling services at optimal prices, and managing cash flow effectively.

Your Target Income

First, you must determine how much revenue you have to generate every year to meet your goals and obligations. Again, depending on why you want to freelance, this might be significantly more or significantly less than what you earn right now. Don't lose sight of your goals, even when money is involved.

At the very least, the amounts you invoice to customers must cover the following:

• Living expenses. How much must you contribute to your household every month? What do you need to be happy? Make a reasonable budget, and include everything you need and want: rent/mortgage payments, transportation, insurance, clothing, vacation, petty cash, groceries, cable TV, savings, and so forth.

• Income tax. Fill out a tax return in reverse, starting with the after-tax income you need for your household budget, and determine the required pre-tax, after-expenses income.

• Business expenses. You will need a new computer every two to three years, software, office furniture, books, Internet access (don't forget anti-virus and firewall software), postage, trips to trade shows, training, transportation, professional services, and various supplies. Talk to a tax specialist to see what you can write off, what you must amortize over several years, and how you can use your home office as a deduction. Typical expenses amount to about 20% of sales every year, give or take 5%. Yours might be higher, especially if you need to lease office space or hire an assistant, but tax authorities frown upon anything in excess of 50%.

Case Study 2.8.1 includes a simple target income calculation.

Case Study 2.8.1: Financial Planning

Here is a sample grid to help you plan your business' finances:

Sales Objectives	Value	Formula	Result
Monthly household needs	$2,500	12	$30,000
Average tax rate	30%	$30,000 / 70%	$42,800
Expenses	$10,000	$42,000 + $10,000	$52,800

Working Hours	Value	Result
52 weeks 5 days	260 days	260
Minus: Vacation	20 days	240
Minus: Holidays	10 days	230
Minus: Sick days	5 days	225
Minus: Trade shows	15 days	210
Total, at 7 hours per working day:		1,470 hours

Billable Hours	Value	Result
Working Hours	1,470 hours	1,470
Minus: Training	200 hours	1,270
Minus: Banking and invoicing	30 hours	1,240
Minus: Shopping for supplies	20 hours	1,220
Minus: Marketing and promotion	150 hours	1,070
Minus: Office maintenance	25 hours	1,025
Minus: Various contingencies	25 hours	1,000

Hourly Rate

Basic average rate:$52,800 / 1,000 hrs = $52,80 per hour

"Rule of 800" target rate:$52,800 / (80% 1,000 hrs) = $66 per hour

The Rule of 800: Calculating Your Billable Hours

Next, you must determine how many of your working hours you will be able to bill to clients. Again, refer to Case Study 2.8.1 for an example.

First, find out how many hours a year you will spend working. Take into account the length of your normal workweek, vacation, holidays, sick days, and travel time going back and forth from your home to trade shows and clients' premises.

Then, subtract time spent on tasks not directly related to client assignments, like marketing your services, banking, shopping for supplies, invoicing, training, cleaning up the office, installing software upgrades, and handling of all the other chores someone else would be taking care of in an ordinary company.

For most full-time freelancers, this computation will result in about 1,000 billable hours a year. However, you may want to cut that number by 20%, to about 800, to account for slow periods (which you can't always spend training) and for bad payers.

Your Target Hourly Rate

To determine your hourly rate, divide target income by billable hours. This is an average; on occasion, you will have to accept a lower rate because a client has limited resources or a project is just too interesting to pass up. This is another reason to apply the Rule of 800: having a higher base rate will give you a margin with which to work.

In most cases, the calculations in Case Study 2.8.1 will yield a rate that is about twice an employee's hourly salary for similar work. This is perfectly normal; the client expects a higher fee because he does not have to pay office space, benefits, vacation time, and so forth.

Financial Safety Margins

[Laurance88] suggests setting aside the equivalent of 3 months' living expenses and 3 months' business expenses before you launch your business. This is enough to bridge the gap between your last paycheck and the first payments you will receive from clients, 30 to 60 days after you have delivered the work.

Then, to assure your business' long-term viability, gather an emergency fund twice as large—and restore it as fast as possible after drawing funds from it. Otherwise, a few months without assignments or a big client going out of business while he owes you money will leave you in financial difficulty.

Other Considerations

The pricing method outlined previously will work in most cases, but be wary of the extremes:

• Even if you need little money, do not undersell your services. Clients often assume that "cheap" equals "shoddy."

• If you determine that you need $100 an hour for work that full-time employees do for $30,000 a year, your business is unsustainable. Change your assumptions.

• If you constantly find yourself turning down business because you're too busy, you might be able to raise your prices at no risk.

• If you're in a bind, you might have to take assignments at discount prices. The shorter the better in this case, because you don't want to tie up time that you could sell at premium rates later on.