This handy guide will teach you how to do budgeting and forecasting so you are fully prepared to handle the ups and downs of a small business.
GENERATE REGULAR INCOME
When you start your own business, the first thing you should do is make yourself a paid employee. That way, you may have the best of both worlds: a consistent, predictable salary and the freedom to be your own boss.
As you are most likely aware, inconsistent income is a part of the life of a freelancer. However, you can approach that irregular revenue in such a manner that it becomes regular for forecasting reasons. To do this, calculate your average monthly income and divide it by 12 to give you a good starting point for your salary.
It’s preferable to be more conservative while budgeting because life doesn’t always go as planned. You can always strive to improve your base salary, but things aren’t always in your control, so being conservative can be very prudent.
Unfortunately, you will not be able to keep your full salary. You will also need to take taxes into account. Salaried employees have taxes deducted automatically, and you must account for this now that you have been converted to a salary. The amount you should deduct is determined by your income as well as a number of other factors, such as how much you claim for business expenditures.
There are handy tax calculators available online to help you determine how much tax you should be forecasting each month.
ESTABLISH A SYSTEM
There are many ways by which you can pay yourself, but the one that most closely resembles how staff are typically paid is to open two separate bank accounts. Transfer all of your freelancing revenue to one bank account, then transfer your paychecks to your personal bank account, from which you will withdraw cash, pay bills, and so on.
This approach will make you feel as though you have a consistent income on which you can rely, that you are not overspending in the good months, and are not reverting to eating rice and pasta in the poor months. By deducting taxes from your paycheck, you’re automatically saving money for those dreadful occasions when your tax payment is due. Of course, there is an obvious flaw in this phase. What if the wage you pay yourself is insufficient to cover your expenses? We’ll get to that later.
ESTIMATE YOUR COSTS
We’ve looked at revenue, therefore the next stage is to get a grasp on your expenditures and forecasting expenses so you have an exact picture of all your monthly outgoings. Even little sums can add up, so include everything.
The more time you can spend forecasting your costs, the more accurate your results will be. The key thing is to stick to your actual, real-life spending rather than your predictions of what your spending could or should be. Our predictions are sometimes overly optimistic, and analyzing your real expenditure frequently uncovers surprises.
The objective here is to create a basic list of your spending in several categories:
- Rent
- Utilities
- Insurance
- Transport
- Food
- Socializing
- Entertainment
- Gifts
If you aren’t monitoring your finances, you might overspend yet assume everything is OK. However, you wouldn’t be putting money down for rainy days or paying your tax payment and could find yourself running out of money.
MAKE WORST-CASE SUMMARY PROJECTS
A budget is a document that looks forward, which helps with forecasting and assists you in estimating how much money you’ll generate next month or three months from now. In this phase, you will utilize the information you have acquired thus far to generate some future forecasts.
If you want to do it the old-fashioned way, utilize an Excel spreadsheet. Monitor spending money by month and add a column to predict future spend for each item. Keep track of your real revenue and spending for the current month in a separate column. When the month is up, duplicate the figures and start over for the next month.
Income is forecasted for the next months by inputting the dates when you expect payment to arrive and assuming the worst. For example, if you’re completing a $1,000 project for a client in May, you probably won’t receive the payment until a month later. But, just to be cautious, budget it for July.
Looking at the forecasts, you can see that you’ve covered May, but you’ll need to work harder in June and July to bring in additional money.
PREPARE FOR ONE-TIME ITEMS
In addition to your regular spend, you will also have one-time purchase and vacation expenses.
Because these things are not covered by your usual budget, you will need to save for them. This is something you can do with an emergency money fund. An emergency fund is commonly used in personal finance to cover problems like your roof collapsing, but it may also cover enjoyable things like unexpected invites to vacations on the other side of the world.
To make this work, you’ll need to set aside some additional money each month to contribute to your emergency fund.
DIVERSIFY
This is not something you typically hear in the context of budgeting, but it can be very necessary. It’s great to have consistent work from one customer, but what happens if you lose that client? When businesses need to cut costs, freelancers are frequently the first to leave. There is no job security, no remuneration, and no notice period (unless it is very regular employment and it is mentioned in your contract).
If that employment accounts for 90 percent of your income and you receive the dreaded “We’re sorry but…” email, you’re likely to fly into full-fledged panic mode. Your bills will continue to pile up, but you will only have a fraction of the revenue. Diversification comes into play here. You should aim to diversify your freelancing income by working with a few consistent paying clients. Try not to rely on a single customer for more than 50% of your income.
That way, if you receive the ‘Dear John’ email, it will be unpleasant but not the end of your sole tradership. You’ll be able to pay your rent and other necessary costs while you look for new job to replace the contract you lost.
REMAIN ON TOP OF THINGS
Because your financial situation as a freelancer is so volatile, you must keep track of your incomings and outgoings and know where you stand each month. If you have a sizable emergency fund and a monthly income that allows you to meet your normal costs while still contributing to your savings, you can afford to be more hands-off. However, if you rely on finding new employment each month to pay your rent and pay off debt, you’ll probably find yourself addicted to that spreadsheet or app more often than you’d want.
Whatever time you spend, the important thing is to record every item of revenue (which you’ll need to do anyhow for tax purposes) and have an accurate perspective of your projected spending. Then, on a regular basis, ensure that you have enough money coming in to pay your paycheck and that your paycheck covers all of your costs.
DON’T FORGET:
If you’re going to operate as a sole trader, you will need to ensure you have Sole traders insurance in place. Tradies insurance is a form of commercial insurance that covers the hazards and risks that come with working in a trade. It provides different levels of coverage for legal expenses, as well as work-related equipment and tools, and accidents involving you or another employee.
NEXT STEPS:
- Pay yourself on a regular basis.
- Have a firm handle on your expenses.
- Do your forecasting based on worse-case scenarios.
- Don’t forget to budget for taxes, vacations, and unexpected expenses.
- Make an effort to diversify your income as much as feasible.
- Keep things up to date so you know where you stand.
- Put the right insurance in place.