Budgeting as a freelancer may seem like a tall task, but the truth is that whether you’re self-employed or working at a traditional job, the basics of budgeting won’t change: keep track of your cash flow, live below your means, and save!
Irregular income makes budgeting difficult, but it also makes budgeting that much more important. While there are plenty of unique circumstances that freelancers may find themselves in from time to time, it’s still important to figure out a system that works for you personally.
Here are 6 tips to keep in mind:
1. LIST YOUR EXPENSES
How much does your personal life cost? Every freelancer should know what their life costs them on a month to month basis. Make a list of your bills and basic monthly expenses (not including non-necessities like dining out, entertainment, etc). Knowing your financial baseline is important so that you know exactly how much you need to make to cover your personal finances once you’ve covered your business expenses. Establishing a baseline will also help you to determine how many months you have in savings to cover your personal expenses when business is slow.
2. SAVE “SMART”
As a freelancer, there will be times when business is booming and cash seems to be in abundance. Time to celebrate right?... Not quite. As tempting as it may be to buy out the bar the day you get a big check, this is actually an opportunity to save big. Every entrepreneur should have a general sense of their business cycle, i.e. the times of the year when your business tends to peak and/or slow down. A general rule of thumb is to save aggressively during times of abundance in order to maintain your lifestyle (and sanity!) during times of scarcity. If you know that business is usually booming during the summer months, then put in the extra work to earn and save as much as you possibly can. That way when winter comes and business slows down, you’ll be able to live off of the excess that you’ve already set aside.
3. THE PIE APPROACH
When you don’t have the luxury of counting on a regular paycheck, you can’t truly calculate the exact amounts you can save each month to cover your expenses. But not to worry! Think of your income like a pie chart. As a freelancer, you’ll want to allocate a percentage of your income to different categories. Your categories and the percentages you assign to them are completely up to you, but you should at least have separate categories for Expenses, Taxes, and Retirement.
Here’s an example breakdown:
- Expenses (45%) : Bills, Groceries, etc.
- Taxes (30%) : As a freelancer, it’s recommended that you set aside 30% for taxes and pay quarterly estimated tax payments to the IRS. Those that are self-employed paytaxes after business spending, unlike salaried workers that get taxes taken out before the receive their income. The advantage of this is you are paying this 30% AFTER business related spending. You can deduct qualified business spending from your earned income and pay taxes on the remaining amount.
- Retirement (20%) : Retirement, Savings, Investments
- Travel (5%) : Vacation, Leisure, etc.
In the end, it will be up to you to decide what categories in your life are and assign a percentage to each. Then every time you get paid, allocate your income based upon these percentages. This can be done every time you get a payment, or based on the frequency you receive payments (weekly, bi-weekly, monthly).
4. SEPARATE ACCOUNTS
Once you’ve chosen your categories, it’s time to separate them into different bank accounts. Name each of these accounts based on your categories and send your allocations to each account according to your percentages.
Be sure to keep your business and personal accounts separate. This includes bank accounts and credit cards. Doing so will help you to minimize the difficulties of trying to determine what expenses were related to your business when trying to balance your books and spot deductions for tax purposes.
5. PAY YOURSELF
Once you’ve mastered the concept of saving “smart” and have built up your business savings, it’s time to start paying yourself. Use your list of expenses to calculate your personal budget for monthly spending (bills, entertainment, etc). Once you finalize what you want to spend each month, pay it to yourself from your business/savings account. The frequency at which you choose to pay yourself will be entirely up to you. The important thing is that you are no longer getting paid by your clients. Instead, you clients are paying your business/savings account, and you’re paying yourself regular income from it.
Now that you’ve got your system in place, it’s time to automate your process. Creating and automating your system is the key to remaining consistent and finding success.
Designate a particular day each week to go over your financials and make any transfers if necessary. Also, look into automating your major bills to be paid automatically. Most banks offer free online bill pay, so take advantage of it! Instruct your bank to pay each of these bills on the same day each month.
In the end, although your income may be inconsistent, you can still be consistent in the way you choose to manage it. Budgeting successfully as a freelancer will take some hard work, but many people find the freedom that comes with self-employment to be well worth the struggle.