There is no substitute for a well-founded knowledge of the value of the particular professional and/or technical service in the particular field or industry in which you’re operating. Because independent contractors and consultants are such a diverse group offering such a range of professional services in a broad range of contexts, a broad range of circumstances can and do affect the appropriate fee structure in the actual marketplace, there is no-one-size-fits-all way to calculate an appropriate hourly rate.
But what you can do – and what we can help you with – is estimating an hourly rate based on a nominated target annual salary making sure you factor in the time and expenses that if you were working as an employee, your employer would cover.
Step 1 is to determine the number of saleable hours you have as a basis for calculating the hourly rate you want to charge as a consultant/contractor. This involves adding up the hours you need to allow for as non-saleable hours. This includes annual leave, long service leave, public holidays, sick leave, miscellaneous leave (for things like funeral attendance, jury service, etc.), professional development and termination/redundancy as well as the value in hourly terms of costs your employer would have covered such as workers compensation in the case of accident or injury, superannuation and professional indemnity insurance.
An example of calculating non-saleable hours and costs
Based on a 38-hour week, the hourly fee is calculated using a 1980 hour year (i.e. 38 hours by 52.1 weeks) and deducting from the year the following factors:
Thus the hourly rate should be calculated on the basis of about 1210 saleable hours (1980 – 770).
If the contractor/consultant is engaged on a short-term basis, a further factor should be included to allow for the time and overheads involved in seeking contracts (which is non-saleable time). A factor of 20 per cent would not be unreasonable for this purpose. The hourly rate should then be based on 1000 hours. Short-term contracts are considered to be those which last for less than 12 months.
Step 2 is to factor in your operating costs.
This includes things like software upgrades, hardware upgrades, computer maintenance contracts, finance/depreciation on vehicle, insurance (contents), advertising, computer consumables, stationery, postage/courier services, tool maintenance, other office expenses, reference books and journals, subscriptions (ISP/domain name), travel, union dues, electricity, telephone, internet, use of personal mobile phone, insurance (vehicle), registration (vehicle), fuel (vehicle), repairs and maintenance (vehicle), ASIC fees (depending on the business structure) and legal and accounting fees.
Step 3 is to nominate the annual salary you’re aiming to replicate as a contractor.
You need to remember to factor in the risk and uncertainty that you accept as a contractor that you don’t generally have as an employee – that is, the profit you would see as reasonable considering the risk of loss that is now part of your operating arrangements – while there are clearly no hard and fast rules, generally you’d want to see a profit margin of anything between 10 and 30 per cent so take that into account in setting your target annual “salary”.
Step 4 is to then use the formula to determine an hourly rate for either short or long-term work.
Using the formula described here, a contract engineer seeking a salary equivalent of say $100,000 per annum would calculate the hourly fee as follows:
Long-term contract $100,000p.a. / 1210 hours = $82.65 p/h
Short-term contract $100,000p.a. / 1000 hours = $100.00 p/h
And remember if you operate through a labour hire agency, often the agency puts employment arrangements in place and provides leave, PI insurance, workers’ compensation and superannuation so these components would be removed from calculations set out in Table 1. In these cases, the rates should be altered to take account of the costs covered by the agency. A typical calculation made by a contract agency might see the annualised hours rise to around 1600 after the removal of superannuation from the calculation as it is provided by the agency, so that the hourly rate for an equivalent $100,000 annual base salary would be:
$100,000p.a. / 1600 hours = $62.50 per hour
Any travel costs and GST would be on top of these rates, and it may be necessary to factor in an additional charge to cover legal and accounting fees. Care should also be taken to allow for professional indemnity insurance premiums. ASIC fees may also need to be covered depending on the particular business entity or structure the consultant or contractor has in place.
To help take you through the steps, we have an online fee calculator.
To streamline this whole process, we have an online fee calculator you can use to factor in the various items you need to consider at each step. You can access the calculator here.
You can set your own target annual salary and amend the items in Table 1 like annual leave, sick leave, etc. and adjust operating costs to the level that’s right for your consultancy.
If you’re entering into longer-term arrangements, remember to include an escalation clause when setting your hourly rate. Where you’re looking at your client reimbursing you for expenses over the longer term, it’s advisable to include a reference point for expense increases. Selection of an appropriate reference point can depend on the nature of the contract including the types of services being provided, the results which form the basis of the contract, the industry context in which the contract is set, and the geographical location of the project. ABS CPI figures, the ATO’s Reasonable Travel Allowances Determination (updated annually at the end of June) and relevant salary surveys are all possible reference points for escalation clauses.
Charging travel time
And you’ll want to agree ahead with your client on how you’re going to charge travel time as well. In projects which involve interstate, regional or rural travel, travel costs and time lost to travel can be significant and shouldn’t be overlooked at the quotation stage. Under normal circumstances, where travel is required, a Disbursements clause providing for payment for travelling time long with reimbursement of accommodation expenses can be agreed between the parties. This is a sample travel clause if you need it:
Sample clause – Reimbursable expenses/disbursements
(a) The Contractor is responsible for and must pay expenses incurred in fulfilling the terms of this contract other than expenses nominated in this clause or as agreed between Client and Contractor.
(b) The Client will reimburse properly incurred expenses including travel related expenses (and any other disbursements nominated by the parties such as accommodation, taxi fares, etc).
(c) A travel-related expense is defined as costs and time incurred in travel properly incurred to fulfil the terms of this contract.
(d) The Client will reimburse properly incurred travel-related expenses in full.
(e) The Client will reimburse properly incurred travelling time at the rate of X per cent of the Contractor’s hourly rate.
(f) A travel-related expense is properly incurred by or on behalf of the Contractor if (i) the expenses are approved by the Client; and (ii) the expenses are properly substantiated.
Hourly rates or fee per project
Contractors should also note that where contractors need to satisfy the PSI Results Test, an hourly rates clause and/or disbursements or expenses clause can be regarded by the ATO as indicators that the contractor’s exposure to commercial risk is limited precisely because contractors are meant to cover their own costs and expenses as part of total project cost. If PSI is an issue for you, you should consult with an Accountant or Solicitor before including an hourly rates clause or a disbursements/expenses clause in your terms of engagement. Chances are, the ATO will consider it an indicator that you’re not a Personal Services Business and you’ll be subject to the PSI rules and required to pay tax on your earnings as personal services income.
Recommended hourly rates
Based on full-time Professional Engineer remuneration identified in this survey and the methodology outlined in this section, Professionals Australia recommends rates in the following ranges for short-term and long-term contracts if contractors wish to be remunerated commensurate with their full-time employed peers at each responsibility level.