Freelance jobs can be like London buses: you wait ages, and then three come along at once. Clients also pay on varying schedules, from same-day to same-year-if-you’re-lucky.
Add those two factors together, and you get a whole lot of income instability. One month you might have the income of a corporate banker, and the next month you’d have made more money working at McDonald’s.
So in this tutorial, I’ll show you how to construct a rock-solid budget that accounts for these ups and downs, making sure you save enough in the good times to cover the months when no work comes in or a big project gets cancelled.
I'll be drawing on my own experience as a freelance writer, as well as a few budgeting principles I’ve learned from writing about personal finance for The Wall Street Journal. But the techniques will apply no matter what field you’re in. So freelance photographers, designers, developers and more—read on, and learn to put the “free” back in freelance!
1. Create a Regular Income
The first thing we’re going to do is convert you into a salaried employee. That way you can have the best of both worlds: a regular, predictable paycheck, and the ability to work in your pajamas.
Does that sound too good to be true? Well, maybe it is, to some extent. As I mentioned, irregular income is a feature of the freelance life. But we can treat that irregular income in a way that makes it regular for your budgeting purposes.
Here’s an example to show you how it works.
Look at Your Average Income
Let’s say that my income over the past year looked like this:
What a mess! No pattern, no progression. One month I’m earning more than $7,000, and the next month I’m earning $1,256.
So to make it more regular, I’ll take an average. Add up all those figures and they come to $48,000 for the year. Divide by 12 and I made an average monthly income of $4,000.
I like to be conservative when I’m budgeting, because life doesn’t always work out the way you want it to. So based on these figures, I’d probably plan for an average monthly income of $3,500 for the coming year. I always aim to increase my income, but I understand that some things are out of my control, so I feel more comfortable with a slightly lower figure for budgeting purposes.
But unfortunately, $3,500 won’t be my paycheck. Don’t forget that salaried employees have taxes deducted automatically. As a freelancer, you generally get to pay later, but I said we’re converting you to a salaried employee, so we need to take the rough with the smooth.
The amount to deduct will depend on your income and where you live, as well as a whole lot of variables like how much you claim for business expenses. There are calculators to help you, like this one for the USA and this one for the UK. Because I like round numbers, I’ll set aside $1,000 a month for tax, leaving me with a monthly paycheck of $2,500.
Set Up a System
There are a few different ways you could pay yourself these paychecks, so just use whichever one you’re most comfortable with.
The one that most accurately mimics salaried employment is to set up two different bank accounts. Direct all your freelance income into one bank account (preferably a savings account, if you can find one that actually pays a decent interest rate these days). Then transfer your paychecks into your personal checking account, from where you’ll take out cash, pay your bills, and do everything else.
If you don’t want to bother with separate accounts, you could simply use a single account, and keep track of your paychecks in a spreadsheet or your financial software of choice.
Some people find cash to be the best way to stick to a budget—you have a certain amount of cash for the month, and when it’s gone, it’s gone. So another option would be to withdraw your paycheck from the ATM (probably in smaller installments, to reduce the chances of being mugged).
Whichever method you use, the point is to have a system that makes you feel as if you have a regular income. That way you don’t overspend in the good months, and you don’t starve in the bad months. And by deducting tax from your paycheck, you’re automatically setting money aside for those dreaded moments when your tax bill or estimated payments are due.
Of course, there’s an obvious problem with this step. What if the salary you pay yourself doesn’t cover your costs? We’ll deal with that next.
2. Work Out Your Costs
We’ve looked at income, so the next step is to get a handle on your costs.
This step is very simple, but very tedious. It just involves listing all your expenses—both regular and one-off. Because it’s tedious, many people skip it, or don’t do it comprehensively. But it’s very important to get an accurate view of all your monthly outgoings. Even the small amounts can add up, so include everything.
Fortunately it’s a lot easier than it used to be. The traditional advice was to carry around a pen and notebook, and jot down all your expenses. Nowadays, there are so many apps and software packages that can help you, making it easier to record expenses and sort them into categories. Personally I use Toshl Finance, but there are plenty of others that would do the job. Or feel free to use that pen and notebook if you prefer!
The longer you can do this for, the more accurate your results will be. The important thing is to go with your actual, real-life spending, not your estimates of what you think your spending could or should look like. Our estimates tend to be over-optimistic, and tracking your actual spending often reveals surprises.
The goal here is to end up with a simple list of your spending in different categories, with a total. Here’s a simplified example:
Houston, we have a problem. My monthly spending is $3,000, but my paycheck is only $2,500.
This perfectly illustrates why it’s important to have a budget. If I weren’t keeping track of things, I could survive for a while at this spending level, thinking everything was fine (remember, my average income was a healthy $4,000). But I wouldn’t be setting aside enough for rainy days, or for paying my tax bill.
It’s obvious that I need to take action. Either I go out and search for more work, or I cut my expenses. Something has to give.
In this case, I look at my expenses and decide that I could trim $500 by cutting some of my spending on socializing and entertainment. So I’ll keep my paycheck the same, and trim my expenses to $2,500.
Clearly, however, just covering my regular monthly costs is not enough. I also want to pay down debt, save for retirement, plan for emergencies, and have money available for major events like vacations and friends’ weddings. We’ll take a look at that in the next section.
3. Make Worst-Case Projections
We’ve looked at both income and expenses now, but only in the past. A budget is a forward-looking document, making projections into the future and helping you estimate how much you’ll make next month or three months from now.
So in this step, we’ll use the information we’ve gathered so far to make some projections into the future.
Again, there are plenty of different apps and software packages you can use. Here’s a very short list of options (there are lots of others):
- Quicken Home & Business (or the more business-oriented QuickBooks)
Personally I use a simple Excel spreadsheet that I created myself and have adapted over time. I’ve attached it to this tutorial for you to use as a template if you want. It’s the exact model I use, but I’ve taken out my personal data and replaced it with the fictional numbers from our example.
If you open it, you’ll see that it goes month by month, listing income and expenses in the past (shaded grey), and the same items projected into the future. There’s a separate column where I track my actual income and expenses for the current month. When the month is over, I’ll copy those numbers into “May-15”, and start fresh for June.
I project my income for the coming months, entering the dates when I think I’ll get paid, and assuming the worst. For example, I’m completing a $1,000 assignment for Client 3 in May, and expect to get paid about a month later. But to be on the safe side, I’m putting it in the budget for July.
By looking at the projections, I can see that I’ve got May covered, but I need to hustle to bring in more income for June and July.
Planning for One-Off Items
You’ll also notice that my “expenses” category includes a couple of extra lines, for “Vacations” and “Major one-off items”. This is where I plan for things like vacations (obviously) and other big expenses that don’t fit in the regular categories.
Because these items are outside the normal budget, I need to save up for them. I do that with an emergency fund. In personal finance, people usually talk about an emergency fund as being for things like your roof caving in. But I also use it for fun stuff like an unexpected invitation to a wedding on the other side of the world.
For this to work, of course, I’ll need to save a little extra each month to add to the emergency fund. Based on my prior expenses, I’ll budget $6,000 a year for adding to my emergency fund, both for major planned expenses and for stuff like the roof caving in. So that’s an extra $500 a month.
I also want to put aside another $500 a month for paying off my debt and saving for the future (retirement, being too ill to work, and other unpleasant prospects). So I need to aim to increase my average monthly income from $4,000 to $5,000.
That way I can still pay myself a $2,500 paycheck, and I can still cover my tax bill, but I’ll also have enough left over to pay off my debts and build up an emergency fund and long-term savings.
This is not something you hear very often in the context of budgeting, but I’ve found it to be absolutely essential.
Getting regular work from one client is fantastic, but understand that any freelance gig is inherently unstable. When companies need to cut costs, the freelancers are often the first to go. Unlike with regular salaried jobs, there’s no job security, no compensation, no notice period (unless it’s a very regular job and it’s specified in your contract).
So consider the possibility that you’ll wake up one morning and get an email saying, “We love the work you’ve been doing, but...”
How would you respond? This is where diversification comes into play.
If that job represents 90% of your income, then you’ll likely go into full-scale panic mode. You’ll be faced with the prospect of paying all those bills you identified earlier, but with a fraction of the income.
On the other hand, if that job is just one of five or six regular jobs you have going, the “Dear John” email will be unpleasant, but not vertigo-inducing. You’ll still be able to pay the rent and other essential expenses while you search for more work to replace the contract you lost.
That’s why I recommend trying to diversify your freelance income stream among at least three or four regular clients (plus a steady stream of one-off jobs if possible). Try not to let any single client account for more than 50% of your income.
(I have to admit that I’m violating my own rule at the moment. I’m doing a lot of work for Tuts+, and if things go wrong, I’ll have a big hole in my budget. But the promise of so much regular work for a company I like was too enticing, so I made an exception. I’d still recommend the 50% rule if possible, but feel free to bend it if you get a great offer.)
5. Stay on Top of Things
In my tutorial on managing cash flow for businesses, I mentioned the general rule that “the more precarious your cash position, the more detailed your forecasts should be.”
For individual freelancers, exactly the same rule applies. Because your position is inherently more precarious, you’ll probably have to spend more time on budgeting than your office-bound friends do. It’s just part of the trade-off.
How often you need to budget also depends on your individual position, however. If you have a nice juicy emergency fund set aside and are pulling in a regular income that allows you to cover your regular expenses and add to your savings, then you can afford to be more hands-off. But if you’re depending on getting new work each month to cover your rent and pay down debt, you’ll likely find yourself glued to that spreadsheet or app more often than you’d like.
No matter how much time you spend, the key thing is to record every item of income (you’ll need to do that for tax purposes anyway), and have an accurate view of your expected expenses. Then monitor regularly to make sure that you have enough coming in to pay your paycheck, and that the paycheck covers all your expenses.
In this tutorial I’ve shown you how to budget for a fluctuating freelance income. You’ve learned how to pay yourself a regular paycheck, how to put aside money for taxes, savings, emergencies and major expenses, and how to adjust your budget to ensure that you’re meeting all your goals.
As I’ve mentioned, the specific techniques you use can vary. There are plenty of apps and templates and software packages that can help you, far more than I had space to mention here. So feel free to use whichever resources work for you, and adapt my budgeting method to suit your own needs.
Just keep in mind the most important principles:
- Pay yourself a regular paycheck.
- Have a realistic grasp of your costs.
- Make projections, and assume the worst.
- Don’t forget to plan for taxes, vacations and emergencies.
- Diversify your income as much as possible.
- Keep everything updated, so that you know exactly where you stand.
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