Diving into the freelance world can sound enchanting: Setting your own schedule, being your own boss, doing your own thing. Except for one pesky problem: Freelance finances.
You have to pay the bills somehow, and the accounting department is not coming to the rescue. You are the accounting department (and every other department). One-third of the U.S. workforce may be freelancing, but they still have to pay the bills.
Before making the leap you need to figure out your freelance finances. It’s the math that makes freelancing work.
How Much Do You Need?
The biggest question to figure out is how much money you need. That’s the million-dollar question (and hopefully not how much you need).
The foundation of your freelance finances is figuring how much money you need to survive. You’ll need to come up with a baseline number that’s the minimum you need to get by. This will include your own salary (so how much do you really need to live on?), all freelance expenses (office, computer, cell phone, etc.), retirement, insurance, a little cushion so you’re not cutting things too close and don’t forget taxes.
There’s a lot to consider for your freelance finances.
Freelance Finances: Expenses
We’ll start with your expenses. What do you need to spend money on for your business? This can be a long list, so you’ll need to be thorough and think of everything:
- Online services
- Cell phone
- Office space
- Office supplies
- Bank fees
And that’s just a start. There’s a lot you have to pay for when you’re on your own. Freelance finances aren’t simple.
When talking about expenses you also need to figure out how to keep them as low as possible. The lower your overhead, the easier it is to turn a profit.
The easiest way to make your freelance finances work is to spend less money. That sounds obvious, and it is, but it’s harder to do in practice. Do you really need the super swanky office? Can you make your computer last another year? Do you need to attend that many conferences every year?
You want to have a startup mentality and keep things cheap. Amazon used cheap doors as desks to save money when they first started. Those kinds of strategies can help your company keep the expenses in check.
But it’s not just your business expenses. You also need to look at your personal expenses. If you’re living life large then your salary will need to match. But if you can find ways to cut your personal expenses and survive on less, then your freelance finances start looking a lot better too.
This might be where some people get confused. Aren’t you going freelance so you can make more money? Maybe. You might end up making more money, but you might not. Especially in the beginning.
But the surest way to fail is to assume you’ll make more money, live like you will, and force your freelance finances to deliver. With those high-income demands, your business has no room for error. The slightest financial problem will ruin you. But if you cut your expenses, tighten the belt and be prepared for some lean living, then you have more margin. If things get ugly, you’ll be able to survive. But if they go well, you’ll have room to boost your spending without worrying about jeopardizing your business.
Starting out with fewer expenses was a big help to freelance WordPress developer Bill Erickson:
“One thing that really helped me getting started was that I had minimal expenses. … A lot of freelancers can understand this—having those lower expenses you’re able to succeed faster and grow your business from there. … I could experiment without having a ton of bills to pay.”
In many ways the key to making your freelance finances work is to minimize your obligations. What do you have to pay for every month? What are the bills you absolutely must pay? The Internet bill and your mortgage are probably pretty crucial, but going out to eat all the time or going to the movies probably isn’t something you have to do.
Reducing those non-essential expenses gives you more freedom.
Nothing takes away your financial freedom like debt. Talk about obligations! Every debt you owe is money you must come up with every month. The more you can minimize business and personal debt, the fewer obligations you’ll have and the more room you’ll have to make your freelance finances work.
It’s a strategy that freelance WordPress developer Curtis McHale employs:
“I have no debt outside of my mortgage, so my expenses are super low. A couple bad months means I can cut what my normal salary would be in half and still get all the food we need, have a house, etc.”
In the end, it’s always easier to spend less than it is to earn more:
“You can never out-earn your spending, it will always catch up to you.” –Curtis McHale
What About Benefits?
Your bills and debts aren’t the end of your expenses. Your freelance finances also need to include your benefits. One of the downsides of leaving the corporate world is that you miss out on benefits:
- Insurance (health, dental, life, disability)
- Vacation/sick time
These are all things you’re going to have to pay for yourself. Maybe you’ll get lucky and can be covered by your spouse’s health insurance. Though in some cases employers aren’t pitching in much for family health insurance. Your spouse’s coverage might be mostly paid for, but adding you or the kids might be prohibitively expensive.
Chances are you’re going to get sick at some point. There will be days when you can’t work, and that likely means you’re not making any money. You’ll need to include that in your freelance finances.
You’re also going to need some time off. But that two-week vacation suddenly costs you more than plane tickets and a hotel. It’s two weeks with no income.
Be sure to include all these extra in your expenses.
Death & Taxes
Another guaranteed expense you need to plan for is taxes. At that cushy corporate job you were paying income tax in every paycheck, through your withholdings.
But there are no withholdings on freelance income. You need to set aside money yourself to pay your taxes. Otherwise you’ll be facing an ugly tax bill. That’s what Curtis McHale ran into one year:
“I didn’t save enough for taxes one year, so I owed $9,000.”
In most cases you’ll need to pay your taxes quarterly with estimated payments. If you don’t pay enough along the way, you could be looking at penalties when you file your taxes by April 15.
This is where talking to a tax professional can be worth your money. Tax software may be easier on the budget, but it might not help with estimated payments.
Freelance Finances: Income
All those expenses can be kind of depressing. Going into business costs a lot of money. So let’s talk about something a little more encouraging: income.
How much do you need to earn to cover all those expenses?
That’s the money question, so to speak. This is where you need to figure out how much money you can realistically bring in.
We talked expenses first because you need a realistic baseline and something to shoot for. Maybe you’ll find that your expenses are low and you’ll have no problem bringing in more than enough income. Or maybe you’ll discover that you’re planning to spend too much and that’s making your income a real challenge. If that’s the case, it’s time to look closer at your expenses and see if you can bring them down. Otherwise, if your freelance finances aren’t making sense, you might need to reconsider freelancing.
A few tips on figuring out your income:
- Feast & Famine – Freelance work is known for the feast and famine cycle. Don’t expect your income to be steady. Look for ways to make your income more dependable, such as retainers or selling WordPress maintenance or security.
- Be realistic – Don’t overestimate. It’s far better to underestimate your income than to overestimate. One means you have extra cash to celebrate, the other means you’re out of business.
- Passive income – The bulk of your income may come from building websites, but don’t forget passive sources of income like affiliate fees. Every website you build needs hosting, and that’s affiliate income in your pocket.
Freelance Finances: Extras
We’ve talked income and expenses, but your budget isn’t done yet. There are two more issues you need to consider:
1. Startup Money
How much money do you need to start freelancing? When calculating your expenses, hopefully you noticed they were front-loaded. There are a lot of things you have to pay for up front, such as office equipment, computers and more. Maybe you can find ways to bootstrap those expenses, but the other challenge is your income is likely to be lower when you’re first starting out.
Why do you think so many startups began in the garage?
You might need extra money to help with the initial transition to freelance work. This might be a good reason to moonlight first and build up your income before going full time.
2. Emergency Money
The other expense you need to consider is emergencies. What happens if a client drops you and you’ve got no income? At your corporate job you had that handy salary coming in every two weeks and life was simple. If things did get ugly and you were let go, there was always unemployment. No such safety net in freelancing.
As a freelancer you have to create your own safety net.
You never know what’s going to happen. Some corporate clients will take 90 days to pay you. They’re not being mean, that’s just their standard practice. Can you wait three months for your income?
It’s also possible you’ll run into bad clients who don’t pay at all. Jobs can go south and sometimes you’re better walking away without any money.
Or it could be unexpected expenses. What happens if your computer crashes? It’s not like you can wait until you save up money for a new computer. You need a computer to work.
The unplanned realities of life make an emergency fund a necessity for every freelancer.
Everybody—whether you’re a freelancer or not—should have an emergency fund. But for freelancers that emergency fund needs to be bigger.
Saving up six to 12 months of income is the standard recommendation. Give yourself plenty of wiggle room. If your expenses are flexible and you can rein things in when income goes south, maybe you can get by with less in your emergency fund.
But think through how much you’ll need. Hopefully you won’t need it. But you never know—that’s why it’s an emergency fund. Emergencies happen.
Build Up to a Full Emergency Fund
Saving up half or all of your annual salary might be daunting task. That’s a lot of money to stash away. You might not get there right away.
Consider starting off with a smaller emergency fund (maybe three months?) and a plan to stash away the rest. You need some kind of safety net to get started, but you can make it bigger as you go.
Just don’t put off building up that emergency fund.
Freelance Finances: You Need a System
Figuring out your money is complicated. This is the less-than-glamorous side of freelancing. But it’s something you have to do. So figure out how to do it well.
Get an Accountant
A big first step is to talk to an accountant. You probably won’t need an accountant on an on-going basis, but you should talk to a professional to get your freelance finances set up properly.
An accountant can talk to you about taxes and retirement plans, which business expenses you can write off and what kind of records you need to keep.
Create a System
Then you need to put a system in place to keep your freelance finances in check.
- Put aside money for taxes and set reminders to make your estimated payments.
- Track and anticipate your income.
- Record your expenses and make sure you’re staying within your budget.
Make Your Freelance Finances Work
This is the math that makes freelancing possible. It’s not always fun and glamorous, but it’s part of the job. Put some serious thought into your freelance finances. Make sure the math works out in your favor. You’ll find it gets easier.
Figuring out your freelance finances will make your freelance career a success.
(Photo by 401(K) 2012)