It’s hard enough to manage your money on a steady, regular income. When your income varies from month to month as someone who’s freelancing or self-employed, keeping your finances organised is even more of a pain. From my experience, you need a system. Set it up once, and it protects you forever. Here’s the system I use.
Illustration: Angelica Alzona
What to Know Before You Freelance
I’ve been a freelancer for several years now, and my clients have mostly been long-term, but there were some “feast or famine” months when I first started. Even now, my income can vary a few thousand dollars per month, especially if I’ve taken time off to go on holiday or something else pulls me from work.
Looking back, I made a few mistakes when I jumped into the freelance life. I had no idea just how different freelancing was from a regular, full-time job. Here are a few financial tasks I should have conquered beforehand:
- Save twice as much for an emergency. I’ve always had an emergency fund, but I underestimated how big it should be when I switched to freelance. As you adjust to your new work situation something will inevitably come up: Business expenses, taxes, health insurance, losing a client and all the other perks of self-employment. My first year of freelancing, I depleted my emergency fund. It was scary.
- Prepare for taxes and insurance. The main reason I drained my emergency fund was that I had no idea how much I owed in taxes. I was used to my employer taking out a portion of my paycheck, so I didn’t pay my own estimated taxes, which is what you’re supposed to do. In Australia, you may pay as you go (PAYG). The cost of health insurance also caught me off guard.
- Keep a cushion for irregular expenses. When your income is unpredictable, the last thing you need are unpredictable expenses. You can get an idea of your irregular expenses if you look at your bank transactions from the past year, but something will always catch you by surprise, even if it’s just a business expense, like video editing software or a course you want to take. In addition to a bigger emergency fund, I should have kept a cushion to pay for expenses like these.
The bottom line: Freelancing can come with quite a few financial surprises. Be prepared.
Separate Your Business and Personal Finances
Most experts and seasoned freelancers recommend keeping separate business and personal accounts. For a long time, I just kept everything combined, and to be honest, my system worked just fine. As my freelance business grew, though, I hired subcontractors to help me manage things like video editing, transcribing documents, keeping up with my schedule and so on. I also started buying a lot more stuff for my business — software, apps, that sort of thing.
In other words, stuff got complicated. Managing my money was no longer as easy as juggling a few client paychecks; I had to budget a handful of other expenses, now, too. What’s more, I had to keep track of those expenses for taxes. Separating my business and personal accounts made it easier to organise all of this. Here are all of the bank accounts I currently have and what they’re used for:
- Business transaction: My main account for client payments and business expenses.
- Business savings: Not totally necessary, but it came with the transaction account, so I use it to save for taxes.
- Personal transaction: All of my personal expenses, from my mortgage and utilities to restaurants and other non-business-related expenses.
- Personal savings: An emergency fund that I never touch (well, unless there’s an emergency).
It seems like a lot to keep track of, but once you set up a system, it’s easy. And when it comes time to write off my business expenses, I can easily find them by looking at my business checking transactions.
A side note: Some bank accounts are strictly for businesses and might require you to provide an ABN. They might offer some perks, but other than that, you don’t need a business-specific account for your business expenses. You can use any other account — the idea is to just keep your expenses separate.
Calculate Your Average Monthly Income
The glue keeping my entire system together is based on one simple idea: Pay yourself a salary. Every month on the same date, a portion of my business income is automatically transferred into my personal checking account. It’s like getting a paycheck from an actual employer, but that employer is me!
A lot of advice suggests working backward: Calculate your monthly essential expenses, then figure out how much freelance income you need to pay for those expenses. That’s not really helpful when it comes to budgeting the irregular income you already earn, though.
Instead, I’ve found it helps to use your average income for a certain time period: the past 12 months, for example. My income has been fairly steady for the past year, so I’m comfortable with that time frame. If yours jumps around quite a bit, you might want to adjust your own average. During months when my salary is higher than average, I have money left over in my business account after paying myself. During months when my salary is lower, I draw from that leftover money when I pay myself. I also reassess every few months and adjust my paycheck in case my income has dropped.
You may also decide to split your monthly payment into bi-weekly paychecks, which is standard for a lot of full-time workers (in the US at least). Personally, I like to keep things simple, so I pay myself one monthly payment.
Figuring out your average monthly income is the first step. However, before you calculate exactly how much to pay yourself based on this amount, you have to put money toward a handful of other expenses that are essential when you’re self-employed.
Pay for Essential Business Expenses, Then Pay Yourself
When you work for yourself, you don’t have an employer to help you save for retirement or sock away money for taxes. So before you calculate your own paycheck, you have to consider these expenses, too.
Personally, here’s where my own monthly freelance income goes, along with the percentage it makes up of my average monthly income.
- Health Insurance (three per cent): I set up an automatic monthly payment to my health insurance carrier every month. The payment comes directly from my business checking account.
- Taxes (20 per cent): Every month, I also transfer part of my income to my business savings account for taxes. I calculate this amount by multiplying my average monthly income by expected tax bracket.
- My Superannuation (10 per cent) I pay an automatic transfer into my retirement account every month directly from my business transaction account. To keep my finances really organised, I should probably set up this transfer from my personal transaction account, which will make it even easier at tax time.
- Business Cushion (15 per cent): I like to keep a cushion in my business account whenever possible. I think of it as an emergency fund for my freelance business. This way, if I want to invest in a tool, product or service to improve my business, I have the cash on hand to do that. After paying my taxes, if there’s an excess cushion in my business transaction account, I transfer the funds to my superannuation.
That leaves about 50 per cent of my average monthly income for my paycheck, and thankfully, that’s enough to cover my budget. If it weren’t, I would adjust my retirement accounts or business cushion. These last two expenses are a little less essential for a business, but it’s important to save for retirement.
Of course, the actual percentages can vary, too, since my income varies. Your own percentages might vary, too. If you’re just starting out and don’t earn much, you may not have the luxury of saving as much for your retirement or keeping a cushion the way I do. I didn’t when I was starting out (and there are some months that I still don’t). Your own tax percentage will vary, too. However, I think these are solid categories to shoot for, even if you have to adjust percentages to match your own situation.
Also, all these transfers are automatic. I set up the transfers through my banks and my insurance carrier. The only thing I have to do is remember to pay my taxes, and I use simple Google Calendar alerts for that.
Figure Out Your Payday (or Days)
Whether you pay yourself once a month or twice, you have to figure out exactly when to receive your “paycheck”.
I determine my payday based on when my clients typically pay and when my bills are due. Most of my bills are due at the end of the month (and if they’re not, I’ve called them to adjust my due dates). And most of my clients pay before the 20th of every month, so that’s my payday. I set up an automatic transfer knowing that this will give me ample time to both get paid and pay my bills.
Any amount left over in my personal checking after paying my bills is mine to spend until the next 20th.
That’s my freelance income method in a nutshell. Separate your business and personal accounts, come up with an average income, assign yourself a salary, then automate your other expenses. It sounds simple enough, but it’s taken me a while to establish it. The details of your own system might vary, but you can use this as a guideline to set up something that works for you.