“For those who think business exists to make a profit…think again. Business makes a profit to exist.” Ray Anderson, founder of Interface.

I ran a small web dev shop that failed because I didn’t understand how much I should have been charging my clients. I started my business with a lot of assumptions that proved to be dead wrong. I was young and had a lot to learn.

If you want to have a successful business you have to learn to be a successful business owner. The most important thing you have to learn to think about is money. Business owners think about money differently than employees.

How Employees Think

The problem often arises when the new business owner is leaving a lifetime of regular employment. Employees, in a rational market, get paid just enough to sustain a standard of living commensurate with the value of their skills.

If you want to make more money as an employee, you have to either gain additional skills or improve the skills you have. In some jobs the skills are measured roughly by seniority, with regular pay increases. The implicit agreement is that the employer should pay more because the work you are producing is of greater value than before.

When you transition to a freelance business, it is understandable that you will try to address the mystery of how much to charge for your services based on the same formula. The new entrepreneur I was talking to this past evening was basing her price point on what she felt her services were “worth” to her clients. Her estimation was based on how many hours it took to produce her work (content writing and social media services) and how much she valued her time.

For example, she felt that if she worked for a big corporation she’d expect to be paid about 30-40k a year for doing this sort of work with her level of experience. Of course, that salary doesn’t include benefits like healthcare or vacation time and she knew that self-employment taxes were important to budget for. Also, that salary is assuming a 40 hour work week, while her clients wouldn’t require that many hours.

Using those assumptions she figured she would need to bill $25 to $30 an hour. However, she was afraid that figure wasn’t competitive, especially compared to the hourly rate of her model salary, $15 to $20 an hour. She decided that she would initially charge the low hourly rate and hopefully increase her rate as she gained experience and more clients.

A Business Can’t Live Paycheck To Paycheck

Her reasoning sounded familiar. When I was first starting out on my own as a freelance developer I had made the same calculations and set my rates at about what I felt was competitive with the alternative – a full-time employee. In order to make ends meet I had to do billable work at a full-time employee’s schedule.

What I didn’t understand was that my business was not an employee of my client. I, as a one person shop, was the employee of my business. If I thought a fair market rate for the services I was providing my employer was, say, $40 an hour, I was welcome to draw that amount as a salary from my business. However, I wasn’t considering the fact that as a business owner I was getting screwed by my sole employee. It wouldn’t make sense for me to employ a programmer for the same rate I was charging clients, but since the employee was me it felt like I was coming out even.

I even had a plan for growth! I hired a junior developer who I paid quite a bit less than I was charging for his billable hours. For awhile, things were great! He put in a lot more billable hours than I ever had because he was afraid of getting fired. I wasn’t afraid of getting fired because, well… I was the boss, right? To make matters worse, still thinking like an employee, I saw the net difference between his pay and my invoice as an increase in my salary.

If I had been thinking like a business owner, the idea that you should devote the profit generated by the new employee entirely to giving the old employee a raise would be absurd. Instead, I thought like an employee and redid my initial calculation of how much value the work I, as the company, was giving my client and gave myself a raise.

I was naive enough to think that this was how people got rich.

How Business Owners Think

Owning a successful business is, statistically, the most likely path to getting rich. Owning a failing business is, unfortunately, a different journey entirely.

It’s really easy to understand how to think like a business if you just consider the simplest businesses around you. Take your dentist, for example. It’s obvious how he makes money. You go in with a sore tooth, he charges your insurance company $900 for two hours work, the insurance company pays half that and you’re done. So is the dentist making $225 an hour? No, he has to pay the lovely hygienist who handed him stabby bits and the crabby receptionist up front. He has pay for the x-ray machine, the x-ray film, the lead blankets, the metal that went into your teeth, the electricity, water, health insurance premiums, business insurance premiums, lawyer fees, license fees, taxes, accountants, rent, office supplies, stamps, dixie cups, rubber gloves and a million other things.

Employees are prone to think that dentists, doctors, lawyers and the like charge a lot of money for their work because they possess specialized skills that make their time more expensive than regular folks. Business owners know they charge those rates because x-ray machines and lawsuits aren’t cheap.

Competing On Price Is A Miserable Way To Live

What if your business doesn’t require expensive machinery or fancy offices? Should you pass all the savings on to your clients? The more important question is – how much money do you need to invest in your business? Do you need to budget for advertising? What about learning materials to keep up on your area of expertise? What about your vacations or training new employees?

Often when I talk to new freelancers about this, they object “Why would I expect them to pay for my supplies and education?” The answer is: Who do you think is going to pay for those things? If you are thinking like an employee, you see that doing your taxes and advertising for new clients doesn’t provide value for your client. How can you make them foot the bill for those things?

As a business owner, you know that those things are part of the cost of doing business. Making a profit is not a sin or a scam. If a business providing me services doesn’t make a profit, it will either fail or stagnate. Neither of those results is helpful to me.

An employee thinks of price as “how much what I’m getting is worth,” while a business owner thinks of price as “How much it will cost me to get what I need.” As an employee, I think that if something I bought isn’t worth what I paid, I’ll just return it. As a business owner, I am more focused on the lost opportunity, time and profit that a defective purchase will cost me. Price is one of the least dynamic attributes.

The key difference between the two is that the employee is a consumer and the business owner is a producer. An effective tool in the hands of a consumer will bring enjoyment; in a producer’s hand it will bring money.

Grow Your Business Not Your Work Week

One of the entrepreneurs I spoke with this week expressed frustration that his clients would get a bill for 10 hours and then complain that he was not giving their project enough attention. “They don’t understand that I bill them for the hours I work for them, but not for the hours I spend learning, invoicing and all the other things!” He complained.

I told him it sounded like he wasn’t charging enough. If your clients are pushing you to bill them more hours in a week then they obviously think they’re getting a really good deal.

If you can’t make a living without billing 40 hours a week then you are too cheap. If you can’t find clients that will pay you more, it’s possible that you are providing a service that simply isn’t sustainable as a stand alone business. In that situation, you have two choices: learn more valuable skills or learn to delegate and automate your work so that you can make a reasonable profit.

Recipe for Burnout

It is possible for a cash-starved business to stumble along without ever crashing. Is that what you went into business to achieve? It is impossible to grow a business without generating the cash needed to tune your business model. A business that doesn’t have time to pursue new clients or the money to hire new employees is just waiting to die.

Eventually, you will hit a snag with a project that doesn’t work out or an unexpected sickness or expense that will strain your budget until it snaps. Your clients will then grow impatient. You will find yourself staying up late, frustrated and tired. You’ll look at the work you have lined up as a burden that is pulling you down. You will begin to resent the business that you thought was your opportunity to escape the rat race.

Instead you’ll be in a race against time and bill collectors, just trying to get by until it’s just not worth it anymore.

Give your business the best chance of success by charging what it takes to grow. Drop the cheapskate clients that needle you for unsustainable rates. You’ll be surprised at how agreeable your clients will be to your professional rates when you approach them with confidence. Finally, you’ll have the pride of doing the best work you can instead of just good enough to be worth paying for.

Illustrations by xverges , used in accordance with the Creative Commons license.