Being a freelancer is a bit of a grey area between “self-employed” and “entrepreneur,” depending on how you define yourself.
While you may be the only person in your business, the capacity to be “bigger” than you are is at an all-time high today. Managing a website and blog, having a well-defined brand, cultivating a collection of loyal followers and clients – these are all keys to success in the freelancer world if you intend to go the distance on your own.
What tends to fall by the wayside in this one-person business is finances. As a freelancer, you’re subject to the same responsibilities and liabilities that a business has, but you’re managing them from a personal point of view (which has the potential to make things a lot messier).
Here is our simple guide to get started managing your freelance finances.
Creating a ‘freelancers’ budget
Many folks leave a hearty career to become freelancers. Most people who do this realize that they are leaving behind a steady paycheck, but they forget about the many other financial benefits that come with full-time employment:
They leave behind health insurance, paid vacation, sick leave, a coffee maker in the break room, end-of-year bonuses, sometimes financial reimbursements for “job expenses” like mobile phones, internet, car, and gas.
As a freelancer, you still have these expenses – only now it is you who is responsible for them.
Regardless of what you charge or earn per hour (as these are distinctly different), having a realistic budget set up-front ensures you’re prepared for the true cost of being “self-employed”.
Here are some expenses you are responsible for that with careful organization, your business can provide for you:
- Your subscriptions + business services like your cloud storage, Adobe Suite, and Spotify Premium
- Any fees incurred once, monthly, or yearly related to banking, business incorporation, or professional organizations
- Health insurance, self-managed
- Auto insurance, if your car is used in any way for your business, like driving to and from an office or to a client’s office for meetings
- Gas and mileage
- Any gear you use for work, like computers, cameras, or other tools
- Insurance for your gear, extended tech warranties
- “Paid” vacation, which as a freelancer means time off that you can afford not to hustle
- Utilities used by your business, which may include your mobile phone, wireless internet, a portion of your mortgage or rent payment if your house is your office
- Business and client-related expenses like buying coffee at the meeting, taking an Uber to meet a client, purchasing office supplies or postage stamps
From this, and any other expenses (i.e., outgoing money from your bank account at any time), develop a monthly, quarterly, and yearly budget.
This is the perfect time to take out your Volt Planner and schedule your bills, expenses, and purchases in your monthly calendars. Knowing how much and when money will be leaving your business bank account is crucial for benchmarking how much freelance work you need to take on to meet the financial goals you set for yourself.
If you don’t currently have a personal budget, use the same tactics above:
- list your expenses and their values
- schedule their departure from your bank account
- keep that budget separate from your business
Know how much it costs to be yourself (in other words, to live the way you want to live), separate from what it costs to be a freelancer. In the future, this budget will be the basis for how we establish pricing, workload, and the ability to pay ourselves for the lifestyle we want.
Freelance finances in three parts: taxes, payroll, savings
What do you mean, all the money I receive in my freelancing checks isn’t mine?
Whether you are an entity or a single, unincorporated person doing business, you are responsible for taxes. In the United States, you’re responsible for federal and state taxes (in most states) and depending on how much you make and how much you spend, the percentage of your income that is taxed will fluctuate.
Most freelancers pay quarterly taxes, based on how much they expect to earn that year and the tax rate associated with that level of income. This is different from what you do when you work full time and taxes are automatically withheld from each paycheck; now you are the one who needs to track this amount, set aside the money, and send it in to the government.
This means that each time you receive a check, a portion of that check based on your estimated taxable percentage should be carved out and saved immediately for quarterly filing.
In addition, when you are an employee, your employer often pays a portion of your taxes. As your own employer, it’s your job to cover this portion of your taxes for yourself.
This means that the number you start out with when estimating how much you’ll “take home” and how much you have to pay your budget is not accurate until you account for what you’ll be sending away (or at the very least, setting aside) for tax payments.
BUSINESS INCOME * TAXABLE PERCENTAGE = TAX WITHHOLDING
Wait a second – payroll? But I’m the only person here!
It’s time to pay yourself what you’re worth.
Whether it’s more or less than you’re used to at your full time job, the market value is just one factor in developing your pricing. To start, we’re going to calculate your (as in human you, not business you) minimum viable income.
PERSONAL EXPENSES + PERSONAL SAVINGS + LIFESTYLE ALLOWANCE = MVI
Your MVI (minimum viable income) is the minimum amount of money you need to live your lifestyle comfortably, in support of your needs and those of anyone depending on you.
Not everyone includes ‘lifestyle allowance’ into their calculation of MVI, but your desired lifestyle doesn’t change overnight because you’ve allotted yourself less money. Don’t sell yourself short – be honest about how you want to live and achieve that. Attempting to cut out every single luxury or non-essential is a recipe for failure – be honest about what you need in order to live a meaningful life where you don’t feel utterly deprived all the time.
Whatever you charge for your freelance services has now been portioned by taxable percentage, minimum viable income for the service provider (you), and has one final step to go.
You may have heard this before, but I’ll reiterate: cash-on-hand is king.
At the very least, having three months cash on hand is advisable. This means that if you were unable to work and produce an income, you could continue your current lifestyle and expenses for three months with what you have in your savings account. The goal? Six to twelve months cash-on-hand.
[(BUSINESS EXPENSES + MINIMUM VIABLE INCOME) * 6 MONTHS] ÷ 24 MONTHS OF SAVING = MONTHLY BUSINESS SAVINGS AMOUNT
If each year you build 3 or more months cash-on-hand, you’re in spectacular business shape!
What we’re solving for: Business Minimum Viable Income
In other words, how much income must you make to run a thriving, successful, comfortable freelance business?
(BUSINESS EXPENSES + MINIMUM VIABLE INCOME) • 1.(YOUR TAX WITHHOLDING PERCENTAGE) + BUSINESS SAVINGS AMOUNT = BUSINESS MINIMUM VIABLE INCOME (BMVI)
An easy way to generalize these numbers is by some simple percentages:
- Taxes: 30%
- Business Expenses: 10%
- Savings: 25%
- Paying Yourself: 35%
This is the primary case for running a lean freelance business where your expenses are low, but by comparison, your output and capacity for earning is high.
Freelance businesses that have higher overhead, such as a building lease, automobile payments, high insurance premiums, multiple subscription streams, and high travel budgets will see an increase in business expenses and a decrease in what you can pay yourself.
To break this down even further, you can solve for how much you need to make per week to cover these percentages, divided by how many hours you want to work, and that number will be the preliminary value you should be charging as a freelancer.
BMVI ÷ 80 (HOURS PER MONTH) = HOURLY FREELANCE RATE
Here’s how to deal if your calculated freelance rate is way off-base for your industry
Did the math and found out you need to make $1,000 per hour as an entry-level graphic designer? You’re not alone.
Self-employed people and businesses start to see just how many expenses they’ve accumulated when they really calculate their budgets this way. And while it can be hard to discover your brilliant freelance plan might be a little unattainable at the moment, this is the perfect opportunity to lean-out how much you’re spending, what you value in your life, and how to balance those in the face of industry-pricing.
Make no mistake, this is difficult and only half of established businesses make it to the five-year mark, often flailing financially up to that point.
As a freelancer, your financial health is even more crucial because it’s often your sole source of income. There’s no financial assistance if your business fails, or if a client pays late, or if a client doesn’t pay at all. It’s up to you to be prepared for those – and any – catastrophes that can and do happen.
A prepared, protected freelancer is far happier than a rabidly hustling freelancer taking every job with only hope that they’ll be financially secure.
Over time, your financial grip on your freelance business will evolve. None of us have it figured out from the get-go and we all experiences ups, downs, scares, and successes over time. However, the more acquainted you are with your finances, the easier it will be to manage them so you can spend more time serving clients and creating great work.