One of the most difficult aspects of freelancing is getting a handle on the boom/bust cycles of your income stream. No matter who you are, your work goes through cycles, if not volume of work itself certainly with how much you are paid. Regulating that income stream takes careful planning and finesse, but it can be done.
The first thing to realize in terms of approaching this is that as a freelancer/independent contractor you must keep the experience of your business’ income cycles independent of your employee’s experience. This is true of subcontractors as well as yourself. Your business may go through periods of expansion and contraction, but that does not in any way mean that the employee, namely you, must suffer that same fate. Microsoft is a large-scale example of this. Unlike most companies operating with a large amount of debt, Microsoft has enormous cash reserves that allow it to weather almost any economic storm. Another god example is the country of Norway.
The key to solving this problem for the independent contractor can be outlined in a few simple steps that I will look at in detail below. The steps include budgeting, salary negotiation, emergency fund creation, targeted savings accounts and automating finances.
The first thing to look at is budgeting. As a freelancer you must simultaneously budget for two things at once. First is business expenses and second is personal expenses. Some of these will overlap. For example, if you have a home office, part of that one rent check will go to your personal rent and part going to your business rent. Monthly expenses are simple to manage, but it is also necessary to figure out a monthly budget that accounts for annual or periodic expenses.
While this is something that trips most people up, doing so is quite simple. For regular expenses like rent you have a fixed number, say $1000 a month. You know this will come up, like clockwork on the first of every month. Then there are irregular expenses like computer software. I do not purchase a new drafting program every month or even every year, but I do know that at some point I will. I deal with this in the following way. Figuring the expense might be $2400 every two years, I divide that up monthly and get a figure of $100 in my monthly budget.
In my budget I include everything. This means not only am I budgeting for purchases, I am also budgeting for tax savings since I work almost exclusively on 1099s. If my dentist costs $120 a visit for checkups and I go twice a year, then I budget $20 a month towards that. Every expense. The key to making this work is to gather all your expense data together to know what you spend money on not just monthly or weekly, but annually or bi-annually. Do not forget to include fun. I have personal gifts and vacations included in my budget so that is accounted for, as well as the occasional ice cream cone or comic book. Be honest and account for everything, or the system will not work. At some point you will arrive at a figure for your budget. Let’s say $4,000.
Having worked out the budget for personal and business expenses you are ready to move on to the second part, salary negotiation. This part is easy. Your total budget number is your target salary. So as the employee you go to your boss (you) and ask for this. Your boss (you) then says yes. Celebrate with a cocktail.
Getting more serious, your business is not going to make exactly this number every month. There may be months where you clear well over $10 or 20k and others where you make nothing. We’ll deal with this next but the point is your business (you) pays your employee (you) that amount every month to cover all expenses.
Once we have our salary, what do we do with it? Well, most of the money probably goes towards paying bills and other expenses. But some of it will be left over. If your monthly budget is $4,000 and you make $6,000 this month there is a $2,000 surplus. This is where many freelancers get tripped up. Seeing this “extra” $2k they go on a spending spree and set off to enjoy this “flush” feeling. Of course the following month when they only make $2,500 they soon rack up credit card bills and feelings of anxiety.
The point of the budget is to include those fun purchases so that when you make that “extra” $2k you can put it into your business’ bank account to wait for next month’s salary payment to your employee. You include fun expenses so that as an employee you are not looking to embezzle funds from the company. Remember, just because you are both owner and employee does not mean you are not running a business. Treating yourself like an employee will give you and your business long term stability.
Through taking this “extra” money and putting it away to pay future salaries you are creating a savings buffer or “emergency fund” for your business. I like to keep a minimum of 4-6 months of income on hand in case of economic drought. This has proven useful for me when, over the last 18 months the bottom has largely fallen out of my work. I am able to get by on the cushions I have created for my business and while there is belt tightening, there is not immediate crisis.
Next up is targeted savings accounts. Remember that annual expense that we broke down into monthly payments? What we do with it is, through the use of an on-line savings account create a sub account(any online bank should allow this feature) for that particular item. Thus every month, along with paying rent, I put $20 into my “dental” account. Then in six months, I have the money saved up to go to the dentist and my regular cashflow/life is uninterrupted. I have targeted accounts for numerous items, taxes, vacations, website, etc. Using on-line savings accounts in this way not only do you minimize the impact on your daily routine, you also begin making a little money on the interest, or at least not losing money due to inflation.
I also keep a generalized account for budgeted items I go under in a particular month. Perhaps I budget $15 a month for stationary. If I only spend $10, then I put the “extra” $5 into my generalized expenses account. No matter how good your budgeting and planning, sometimes you will go over. The purpose of this system is to allow for such overages without causing disruptions to your life.
The final step is automating finances. Much of this is done through the savings plan, and any monthly budgeted savings should be automated as much as possible. Recurring expenses like internet, gas and electrical bills, etc. that can be routed through your bank account or credit card should be. Having set up your structures, you should make the system as automatic as possible to take your concern off of where your money is going and put it towards the work you are creating.
In future weeks I plan to expand upon some to all of these points, but this should serve as a good introduction for now. I hope you find this useful. Feel free to leave comments below.
Irregular income is a very important aspect to handle in freelancing life..thanks for writing about it..
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