Even in the best of times (let alone 2020), people can worry about how they’ll manage the fluctuations of a self-employed income.
And if it’s because of the year we’ve just had that you’re now thinking about self-employment as an option, then you’ll definitely want to know more about how you can plan life around earnings that could fluctuate across the year. Particularly if until now you’ve always relied on a monthly salary with all of your deductions already taken off for things like tax, National Insurance, pension, etc.
Yes, taking the leap to self-employment can give you more independence, flexibility, and increased job satisfaction, but it’s that fear that you’ll be living your life as a reaction to the busy or quiet months that can be the one negative in the midst of all the positives.
However, it doesn’t need to be like that. There are some key steps you can take to set your business up so your income doesn’t go up and down from month to month depending on whether you’ve been busy or not.
Set up a separate business account
If you’re a sole trader, you don’t need to have a separate business account - but we strongly advise it.
That’s because it can give you more clarity around your earnings and your outgoings, your expenses and it makes it easier to do your self-assessment tax return.
More than that, it means you can effectively treat yourself as a salaried employee; paying yourself each month. In this way, you can then see exactly how much “extra” you’ve earned in a busy month so you can decide what to do with it rather than letting yourself get carried away with spur-of-the-moment personal expenses that you later regret!
Put your tax to one side as you earn
Calculate the tax on each amount you get paid and then set that money to one side as you earn, rather than leaving it as a vague guesstimate that you’ll wake up worrying about come January.
If you’re using Coconut, then we can work out how much you need to set aside for tax as you earn. A new tool we’re about to launch makes this easier still as it not only calculates tax on your earnings but automatically moves the right amount into a dedicated tax vault for safekeeping.
But however you choose to do it, just make sure you get it done. You don’t want to crash into the year-end without knowing how much you owe in tax and struggling to pay; creating a “feast or famine” cycle to your earnings.
Build up an emergency fund
Aim to build up an emergency fund for your business that could cover your outgoings for three months in case you hit a really bad patch or there’s some unforeseen event that means you can’t earn (Covid-19 being the perfect example).
Ideally, you want to keep this emergency fund separate from any personal savings plans.
Work out your monthly budget
There are a few ways to work out your monthly budget but they’re all designed to achieve the same thing – which is that you can set aside the minimum you need to survive each month.
You’ll need to know:
- Your baseline - this is what you must earn to get by and is made up of rent/mortgage, utilities, pension scheme, childcare, groceries.
And if you have saving plans and investments you should include these too.
- Your monthly extras - things you could do without if you really had to (say, gym membership, Netflix)
Another way you can do this is to pay yourself the amount you earn in a quiet month. Or you can divide your annual earnings by twelve and pay yourself that sum. (However, this works when you have been a freelancer for some time and feel confident that you can continue to earn at least as much as you did in the previous year.)
Pay yourself a salary
Your salary should be your baseline expenses plus monthly extras, or your lowest month’s earnings, or one-twelfth of your annual earnings.
You should then try to get to a position where you’re paying yourself out of what you earned in the month before, rather than paying yourself out of the money you’ve not yet received.
This will make it easier to see your earnings from month to month so you can proactively decide what to do with any extra money you make in the good times – whether that’s choosing to invest in the business, or using it for personal investments, or choosing to spend it on, for example, a holiday or a loft extension.
What’s so important is to make sure that the money you make during the flush months is not just swallowed up in unplanned expenses -- that could leave you struggling to make ends meet in tougher (or quieter) periods.
Get paid in installments
If you’re taking on a relatively large or longer-term project, don’t be afraid to discuss a payment schedule with the client so you can stagger the amount you’re paid rather than having to live off your savings until the final delivery deadline.
It’s a very normal way of working and you should get this payment schedule agreed in your client contract before you get started.
These are some of the main ways to set yourself up for success so you’re in the best shape to survive a quiet period – but also so you can make really good use of the money you make during busy periods.
An additional benefit is that this kind of planning will leave you feeling more in control and as though your whole life (and family life) is less about just reacting to the month-to-month fluctuations of your business. In this way, it can help you to draw a line between your work and your home life which is so important - no matter how much you love your job.