Note, this is an answer modified from one I gave on the workplace stackexchange.
You need to find out the market rate for an equivalent employee first, then your costs.
The following costs must be accounted for accurately in order to compute an hourly rate just to keep you on par with the salaried employee
G & A (this is accounting speak for computers, software costs, office space, electricity, rent, travel, professional development; things you cannot charge a client for directly)
Overhead (this is mostly labor that you cannot charge to a client, but sometimes includes things I stuck in G & A above)
Fringe benefits (this is retirement, health insurance, liability insurance, workman's comp, taxes, paid time off)
Profit (you need a little of this, you are taking on some risk by not being permanently employed)
Furthermore, the G & A + overhead costs for a contractor are high because contractors typically only work between 20 and 30 hours per week. If you are billing by the hour, you can only bill the actual hours worked for a client.
I recently finished a contract where the scope of the work which I was hired for was equivalent to an engineer in the $115-135,000 annual salary range. I just happened to pick $125,000 as my break even calculation number. Note that I live in the USA.
For this calculation I lumped G & A and Overhead costs together, since for me they are really the same thing when working out of my home office, and I don't have any other employees.
My annualized costs were :
G & A + Overhead : $23,000 (note that this is with no rent, but includes computer upkeep and software licensing, travel, phone, accountant, invoicing software, and other test hardware)
Fringe Benefits : $43,000 (this includes heath, all taxes, liability insurance, etc.)
The above were actual costs. You will need to use your own costs in your calculations.
Now I need to calculate the hourly rate. To accomplish this task, I need to compute how many hours per week that I work on an annualized basis.
I actually worked about 30-32 hours per week on the contract, the rest of the time I was working on billing, accounting, hour tracking, task reports, etc. (all unbillable to the client).
I also need to remember vacation for this calculation, and I'll use 6 weeks of paid time off.
My total annualized billable hours were (52 - 6) weeks*32 hours/week = 1472 hours.
My total costs were $23,000 + $43,000 + $125,000 = $191,000.
This means that my hourly rate must be $191,000/1472 hours = $129.76/hour, just to break even!
This is the no profit rate.
If you want a bit of profit, you need to add that to this rate. For example, to have a profit rate of 10% I would need a hourly rate of 1.10*$129.76/hour = $142.74/hour.
Note that the way I computed the hourly rate here implicitly accounts for paid time off and non-billable overhead labor, if you need or want explicit numbers you can do that as well.
The break-even rate ($129.76/hour) is 2.16 times the 40 hour equivalent of $125,000 per year ($60.10/hour).
Before contracting and setting a rate, you need to figure out all of these costs for yourself, then do the above break even calculation.
Some things you must pay for in the US are :
- Software for commercial use (sans alternatives)
- Various insurance (depends on location)
- Hardware, electricity, internet, etc. for you business
but other costs are up to you. I refuse to go without health insurance, for instance.
If you cannot close contracts at more than the break even number (for hourly billing), then you should attempt to obtain a regular salaried position.
If you choose to not include benefits, retirement costs, etc. in your calculations, you are effectively working for below market rate.