This blog is a little long, and I apologize for that but I combined two of my previous blogs, so as not to split up the topic. If you are paid by commission, this blog will also be very helpful to you. This is the last blog under the section of our outline for a.Determining your budgetable monthly income.
Self-employment can be a liberating, extremely rewarding way to earn your income. Many people who are self-employed are doing exactly what they love and want to be doing. They are their own boss, set their own hours, and consequently have a lot of flexibility. However, it can be a very difficult venture when you are first getting your business going, and also when you are laboring in a business that may not go very far. When you are at the top and a huge contract doesn’t go through, or they are late on payment, it is you and your family who will carry that load. It is definitely a little lonely at the top in terms of responsibility, and yet the rewards can be spectacular.
So how do you budget when you are self-employed? Well, if your business is established and stable, the best option is that you will draw a salary from the business and it will be very easy for you to budget. How you set up your income from your business is entirely up to you and your accountant. You may choose to bill your business an hourly rate, or draw a monthly or bi-monthly salary, or be paid weekly. However, these are all great options in a business with an established clientele and that is at a place of maturity. Many people who are self employed live contract to contract, with their families just praying that the check will come. I am going to primarily deal with this scenario today, as all people who are self-employed have been in this place at some point in their business. Once your business is established, you can set up your budget based on commission, weekly, two week, or salaried budgetable income according to how your income is set up.
The first thing to do is to determine your monthly budgetable income. First of all, take your total gross income from last year, which you can find on your recently completed taxes, and subtract the taxes that you paid or owed for the year (medicare, social security, state taxes, federal taxes). If you are making personal tax payments each quarter on your income, then you will need to set up an “escrow” savings account just for your taxes that you contribute to as part of your budget, and from which you pay your taxes. If you are withholding money for your health insurance or your 401K or IRA through your business, you will need to subtract the yearly total of those from your gross as well. If you are paying for it personally, the payments will just be a part of your budget. This will give you the “net total” for the year or the amount of money you get to take home and live on each year. To find your monthly average net pay, simply divide that total by 12.
The reason it is so critical to know an estimate of what you have to live on, and to have a budget, is that being self-employed with no idea what it is costing you to live is the quickest way to dig yourself a deep hole of debt. During the time when you are establishing your business, your budget may need to be extremely frugal so that your debt load doesn’t end up sabotaging your business and your peace at home. If this is your first year in business, you need to be especially vigilant in your finances. You will have to base your monthly budget on a pure estimate of what you will bring in this year. It is better to be conservative with this estimate than generous, because if you make less than you spend, you will end up in debt.
So you have an estimate of what your monthly budgetable income should amount to each month, the only problem is most business contracts don’t come so precisely and on time. Like a commission-based income, you may have months that are incredible, and months where you pray for the contracts and the checks to come. I am going to at this point ask you please to read my blog on how to set up your income on a commission-based income entitled “Life on Commission: Finally Breathing”. I go into so much detail on how to set up an “escrow” savings account which I would just be repeating here. The premise is that you will save in the times of plenty and supplement your income from that savings in the months when business is not as good.
However, there is a dimension of being self-employed which tends to sabotage budgeting efforts. That is, you tend to live on whatever you bring in. The truth is, you will always spend everything you have, unless you are purposeful with your money. So how do you get purposeful with your money when every check that comes into your business has already been spent by you and your family?
“Budget thy expenses that thou mayest have coins to pay for thy necessities, to pay for thy enjoyments and to gratify thy worthwhile desires without spending more than nine-tenths of thy earning.” ~ This is the second cure for a lean purse according to the book The Richest Man in Babylon by George S. Clason. OK, I love this book so much that (although it is not Christian) I’m just going to say… You have to read this book!! It is told as a story and it reads easily and it will change your life. It is a fantastic book about the power of saving money, and managing money. One of the principles that it lays out so clearly is never spend more than 90% of your income. As Christians we are used to hearing this because we are told to give 10%, but as a Non-Christian book, it urges that you have to save 10% of anything that comes into your hands to ever move beyond where you are. Now I believe in giving and saving which both are so powerful in your financial life, but another wonderful principle I believe in is the power of percentages.
If you are self-employed the power of percentages is going to enable you to be purposeful with everything that comes through your hands, and also find the finances for your dreams. My husband is on salary at his full time job, but he also has several side businesses, which he does contract labor for and is self-employed. Every dollar that comes in through his self-employment is filtered through our agreed upon percentage plan before we look at what is usable from that money. For instance, a certain percentage goes to savings, a percentage goes to pocket money so he can feel the rewards of his labor a percentage goes to giving, and to a dream we are saving for, and then the rest goes to our needs and is available money. So out of every side check that comes in only about 50% of that money is “available”. We never even consider the whole check, we just divide it in half. This needs to become your mentality every month, otherwise 100% of your income will disappear every month and you will perpetually struggle.
So how do you go about setting up your percentages? It is really simple actually; a simple math equation will tell you what percentage to withhold from each check for each category of your budget. However, percentages are mainly applicable for expenses that do not have a definite due date. This is because it just doesn’t work to only pay a percentage of your mortgage payment. It will still be late J. Most of your fixed bills will need to be paid by their due date and that is where having an “escrow” savings account will come into play in self-employment. If you do have a bill, like your mortgage, that is due and you don’t have quite enough to cover it after paying out your percentages, you would then withdraw the needed funds from your escrow account. You do not take the money from your grocery money, or Christmas fund, or vacation fund. This is the beauty of having a storehouse set up specifically for months when your income is lower than other months. At the end of the year it will all average out, so tap into the picture of your whole income and quit thinking in the desperation of the now.
To determine the percentage rate of each of your budgeted expenses, you would take the expense amount, and divide it by your monthly budgetable income. So if your monthly budgeted grocery amount is $600.00 and your monthly budgetable income is $4000.00, your grocery percentage rate would be $600. divided by $4000. = .15 or 15% So lets say that you receive a check for $2500 for a contract that finally paysJ. You would then take that check and immediately multiply it by your percentages before you do anything else. So in our example, take .15 and multiply it by $2500. = $375.00 which you would set aside from that check for groceries. Other bills that I would do a percentage for would be your taxes (ask your accountant to tell you what to withhold for your tax payments), gas money, savings, vacation fund, dream funds, entertainment money, and any bill that is paid, bi-annually or annually and not paid monthly (like car insurance).
I am feeling a little “clear as mud” moment right now and I hope that you are not feeling that way because it really is not that complicated. Basically, the percentage allows you to prioritize living rather than always living on what is left over. So your budget might look something like this (this is just an example, your percentages need to be based on your workable budget of what you can afford to spend in each category!):
Percentages:
Taxes 10%
Giving 10%
Savings 10%
Groceries 15%
Gas 5%
Vacation 3%
Car Insurance 2%
Leaving 45% of every check that comes in for your set bills. At which point I would pay in full whatever bills were coming due at the next bill period, and draw from your “escrow” savings account for anything that you are short on your budget.
Again, I would like to reiterate that this is a plan for people that are just making it. It is not optimal, but it is extremely necessary if you are in the situation of getting a business off of the ground, or if your income from your business is just enough to cover your budget. There are many people who live in the place of “just enough” and percentages, and an “escrow” savings account could truly help you to not just subsist, but to actually thrive. Having consistent money for groceries might revolutionize your wife’s world and keep her from resenting your business, and having a plan for a vacation might just invigorate you into bringing your business to the next level so you no longer have to live in the desperation of paycheck to paycheck.