7 Money Tips Every Freelancer Needs to Know
Dealing with our finances is hard enough when we have a steady W-2 salary. When you add the complexities of variable income and managing business expenses, it becomes even more difficult.
More and more of us are going to experience working as a freelancer at some point in our careers. It’s predicted that freelancers are going to be the workforce majority within the next decade.
The good news is that there are some very doable - yet extremely impactful - things you can do to set yourself up for financial success as a freelancer or entrepreneur.
1. Set aside money for taxes.
Not setting aside money for taxes is probably the most common - and painful - freelancer mistakes I see. In previous jobs when we’ve earned a salary, taxes are already taken out when the money hits our paycheck.
When we work freelance, the money we receive is not really all ours. It includes money we’re going to have to pay in taxes. But if we don’t treat it that way, the money gets taken up by other things and by the time the tax bill rolls around (usually each quarter), we’re scrambling to find the money.
If we don’t have enough available, we have to set up a payment plan with the IRS to pay off last year’s taxes, which makes it even harder to put aside money for the coming year.
Create a tax fund.
We can solve this problem by creating a separate account specifically for money we plan to pay in taxes. The separation is important because then we don’t see it’s there when we login to our checking accounts. If we use an online savings account, we can have it out of sight and out of mind, all the while earning some interest.
Define your tax fund system.
Once we have the space for our tax fund, we want to create a system for how the money will get in there. We may opt to put aside a percentage of every check that comes in or a percentage of your profit at the end of the month. I find the percentage of every paycheck often works better because we aren’t waiting until the end of the month to allocate money that’s already felt like ours!
To find the right percentage, you can talk to a tax professional or estimate based on what you plan to earn and spend in your business. 30% of profit is a great place to start. Depending on our business expenses, that might be 10% or 15% of revenue that comes in.
If you can be more conservative, great. If there’s money leftover after you pay your taxes, that can go towards step #2.
2. Build a rainy day fund for your business.
We talk a lot about building personal rainy day funds where we set aside a few months of expenses in case of an emergency, but we usually don’t think about doing this for our business. For business expenses, this serves as less of an emergency fund and more of a buffer.
Why do we need one? Most businesses have some cyclicality. Many are slow in summer or have high and low seasons. Instead of stressing out and trying to prevent natural lulls (believe me, it’s like trying to move a brick wall!), we can set ourselves up for success (and a lot less stress) by having a few months of business expenses set aside.
How many months?
For many of us, the idea of having months of business expenses set aside can sound incredibly daunting. In that case, we want to start with one and build up from there. When deciding how much you’d ideally like to set aside, think about your business in an average year (or even the last year): how many months in a row did your income come in lower or close to your expenses? How many months of expenses would you need to have in the bank account to feel confident you can ride out any slower business stretches?
Then, you can create a separate account in your online savings account for your business buffer so the money is out of sight, out of mind and earning some interest.
3. Pay yourself first.
Many of the principles of personal finance apply to business finance, and paying ourselves first is no different. I’ve experienced this first hand and I’ve seen it over and over in my clients. We don’t pay ourselves because we believe the business needs to earn more money first. Over time, the business earns more and more, and guess what? We’re still not paying ourselves anything.
To be able to pay ourselves, we just have to do it. I’m not saying you should start paying yourself your ideal salary - yet. It actually works best to start small and work our way up.
Once you’ve decided to pay yourself, you want to make it automatic. Set up an automatic transfer from your business account to your personal account however often you want to receive a paycheck.
If you are worried about cash flow, create a threshold for when you turn off the auto transfer. For example, if my business bank account gets below $2,000, I will turn off the automatic transfer. That way you can pay yourself first and still rest assured you won’t be over drafting as a result.
4. Know that write-offs aren’t free.
This one is more of an FYI than a step you need to take, but I can’t tell you how many times I've heard entrepreneurs and freelancers justify an expense by saying “Oh, I can write it off.” When you work at a big company and “expense” something, you don’t have to pay anything for it, but when you’re a business owner or freelancer, business expenses are paid from your money. If you didn’t spend it, you’d get to keep it or use it for something else.
When something is deductible or we’re able to have the business pay for it, we are getting a discount (let’s say 30%) because we don’t have to pay taxes on it (more about that next), but it’s not free. It’s important to keep this in mind as we make spending decisions and think about our business and personal spending differently. It’s separate, but it’s all coming from the same pot - and that pot is yours!
5. Understand the flow of accounts
A lot of freelancers and entrepreneurs feel overwhelmed by their finances. And it makes sense - there’s a lot more going on - checks coming in and money going out. I find that understanding the flow of accounts can provide a lot of clarity.
Here’s how it works.
Money comes into our business accounts from our client(s). We then want to send off a percentage of that money to our tax fund (ideally as it comes in) so the money is there waiting when it’s time to pay taxes. The leftover money in that account serves three purposes:
It’s money that’s available to pay for business expenses (that will come out of that account).
It's money that can go toward paying our salaries (which will be paid to our personal checking account).
It’s money that can go towards building that wonderful business buffer.
Whatever money gets transferred as our “salary” to our personal checking account is money available for our personal expenses and personal financial goals.
6. Charge enough.
All these great tips won’t work if we aren’t earning enough. After taxes, the next most common mistake I see is that freelancers don’t charge enough. We calculate our rates based on filling our calendar with paid hours rather than taking into account the non-billable hours it takes to find, sell, onboard, and invoice new clients.
Take a time inventory and be realistic about how many billable hours you can work and what each billable hour means as far as non-billable work (this might be a number per client).
Talk to fellow freelancers or search freelancing groups to learn what a competitive rate in an industry is. Make sure you are getting compensated fairly for the type of work you are doing.
Getting paid on time.
Another big complaint I hear from freelancers is that it can take months for the paychecks to finally come in. I’ve experienced this myself, and it can be really stressful and frustrating. The business rainy day fund can help with this, but you can also negotiate with your clients to pay you in a shorter time frame.
It won’t always work, but it’s worth asking. If you agree on a window for payment, make sure to invoice clients as soon as possible and even come up with a late-fee for payments that come in after a certain time window.