How to calculate your required income as a freelancer
Disclaimer: I live in the EU and, more specifically, in Germany. We do have a working social security net, and everyone has an affordable, but also required, health insurance. So if you live elsewhere, you need to adjust the numbers in this post to your situation. I'm also using the terms net and gross in different scenarios. A gross salary means that this is the salary that you negotiate with your employer, but there are additional hidden costs for the company. The net-income as a freelancer is already after VAT because VAT is collected monthly, and you also don't pay VAT with your business expenses. But let's start first and go into more details later.
Becoming self-employed and working as a freelancer is a huge step, and before you can do that, you have to know how much money you need in a year. You also need to know about some specific situations that will happen in year two of your journey.
Before I started freelancing, I had a gross salary of 65,000€. That translates into a monthly income of roughly 5,400€. In Germany, we have many different taxes, and as an employee, you have to pay for your health insurance and into the retirement system. The amount that you pay from the salary is matched with similar payments from the employer so that if you have a gross salary of 65,000€, they pay close to 77,000€ overall. That's a lot, but it comes with retirement savings, health insurance, and insurances if you get unemployed or need a caregiver when you are old. At the end of the day, you have a net-income of ~3,200€ as a single without kids per month. That's 38,400€ a year.
How does your situation change as a freelancer?
As a freelancer, you get the full payment of your client and have to make sure only to spend the amount that is actually yours and not reserved for something else.
This can get complicated, but to make it easy, I went a simple approach. I decided that I have to earn twice my current net-income to be sustainable and add 20% to create some f-you money–but if I struggle to earn the f-you money in the first year, that would be ok, too. This ends at 3,200€ * 2 + 20%: ~7,500€ in monthly revenue. That is 90k, and 90k are a lot–are they?
As a developer and consultant, there are many ways how to earn money. You can have productized services that sell for a fixed price or bill by the hour. In my first year, I billed by the hour only. After making this decision, I needed to come up with my hourly price and followed the path I described here.
To earn 7,500€ a month, I could work for 80€/hour and sell 12 days per month or charge 120€/h and sell 8 days. There are 21 workdays in a month, so selling at least eight at a high rate sounded doable to me, and I went for it. I decided that being self-employed and not able to sell eight days per month means that this is not what I should do. My worst-case scenario was not that hard, and even if I'd fail to sell at the high rate, I might be able to sell more days at a lower rate or also work through a headhunter who connects companies with freelancers. The last option mostly requires working on-site and paying the headhunter a part of what you charge, but it leads to clients who book you full-time. So even with a net-rate of 65€/h, this leads to a monthly income of more than 10,000€–but without the flexibility that I was going for.
In my first year, I was able to sell about 12 days at my high rate on average. I did not increase my spending and got a nice amount of f-you money–which eventually lead to the founding of Beyond Code with my business partner Marcel one year after I started freelancing. At Beyond Code, we started with the lowest possible salaries of 60,000€ and used the same approach to get f-you money again. This money has been invested in making video courses, building products, and even in founding a second company. In our first two years, we were able to increase our salaries carefully, and we are close to 100,000€ per year now.
Starting an own business means becoming responsible for all your taxes. For starting businesses, you usually go for a no-profit policy in year one so that you don't need to pay taxes during the first year and can use the cash flow to grow your business. Unfortunately, that comes with a downside. You pay all taxes for the last year with one payment, and you have to do a pre-payment for the current year (at least in Germany). The pre-payment is calculated based on the previous tax amount and partially for the current year. If your taxes are checked in the first half of the year, it usually 50%, if they are checked late–that happened to Beyond Code–you pay 100%. So at the end of year two, we had to pay all taxes for two years with a single payment–something that can either hurt you very badly or even put you out of business because you spent the money already. Get yourself a good accountant and save for this situation, it happens to every new company in year two. If you are through this moment, you do fine because you get an idea of how much profit you make per year and can do small quarterly pre-payments that don't hurt your cash flow anymore.
The last thing that you have to include in your calculation is your time off. If you are regularly booked by clients, it becomes hard to say that you don't have time and want to go on vacation. On every day on a beach, you lose a daily income. In my case, that was 960€, and a 10 day trip easily costs close to 10,000€ in lost revenue. Become comfortable with that–this is fine. Have it in your mind when you calculate your yearly income and also define your personal enough. Time off prepares you for upcoming projects and eventually leads to better health and more success. It's also a calculation that is rarely baked-on actual data. There will be only occasional months where you bill all 21 workdays of a month–so if you take 10 days off in a month and sell all other missing ones, you are still beyond the required 8 days threshold.
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