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 a weekly, two week, or salaried budgetable income according to how your compensation from your business 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. In this case you will not subtract your taxes to determine your Net income. It will instead be taken out as part of your budget. 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 two blogs on how to set up your income on a commission-based income from May 9th and 10th entitled “Life on Commission: Feast or Famine” and particularly “Life on Commission: Finally Breathing”. They 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? I have a plan for that, but I am going to save it for tomorrow…
In closing today, I want to leave you with this thought from one of my favorite books of all time, “Now I will tell thee an unusual truth about men and sons of men. It is this: That what each of us calls our ‘necessary expenses’ will always grow to equal our incomes unless we protest to the contrary” ~The Richest Man in Babylon
Everything that you earn will continually be used unless you get purposeful with your money. You will always have more desires than what you have income for, and if you let your desires control you, you will always be just a paycheck away from debt or financial hardship in your business and in your family. It is time to take back your income, your dreams, and your life, and this process of establishing a budget is going to help you to do just that. See you tomorrow.