Finance

Budgeting for the Self-Employed

Budgeting for the Self-Employed #theeverygirl

Leaving the corporate world can look like a dream: naps, long lunches, and working wherever and whenever you want. But there’s an ugly side that people on the outside may not see: retirement, insurance, and OH MY GOD CAN I PAY MY BILLS?

Finding your rhythm and feeling like you’re able to actually relax when looking at your bank account is just not the stuff dreams are made of. Sure it might be more difficult to budget and plan as an entrepreneur, but the payoff can be that much more rewarding.

Get control by setting up an easy money management system that doesn’t require a lot of day-to-day work. Then you can laugh all the way to the bank (or not, because you’re an entrepreneur and no one can tell you what to do).

But before setting up a money management system, there are three things you need to do: know your budget, set up multiple bank accounts, and have a buffer.

1. Know your budget

If you kinda, sorta have a good estimate of what your business and personal expenses are, stop right there. You need to get really clear on what the actual number is. Write everything down (Hint: Don’t forget insurance, office supplies, transportation). Split the expenses into two separate buckets: one for business expenses and one for personal expenses. Add up the total for both of these expense buckets and keep these numbers top of mind.

2. Set up multiple bank accounts

Avoiding the feast or famine mentality of working for yourself is like the holy grail of entrepreneurship. It’s a sign that you’ve truly made it when you’re not sweating paying rent during leaner months. To get there, set up a few different bank accounts to keep your money organized:

  • Business checking
  • Tax account
  • Retirement account
  • Personal checking
  • Personal savings

3. Have a buffer

It may take a few months for this system to run smoothly—don’t give up on a good thing too early because you haven’t given it a real chance! Give yourself some wiggle room by having a buffer in your business account. Tip: One month of expenses is a good goal for your buffer amount.

A money management system (that works!)

With those three things done it’s easy to move into a money management system that works. Your money will flow to a few specific places: tax account, retirement account, personal checking, and a savings account.

Tax account: An inconvenient truth about entrepreneurship is that taxes are higher: You’re now picking up the portion of your tax bill that your employer used to cover. There are a lot of ways to estimate what portion of your income you’ll need to pay in taxes, but if you’re looking for a simple benchmark plan to sock away 30% of your income into a tax account. Yes, this really needs to be a separate account. It’s not your money anymore.

Retirement account: Another truth about self-employment is that if you don’t save for retirement, no one else will. After putting away 30% of your business income into a tax account, put 10% directly into a retirement account. Your future self will thank you.

Personal checking: Finally, here’s where you get paid! Take the monthly budget amount you calculated in step 1 and use that amount to give yourself a monthly paycheck. This amount should be consistent month over month. If you have an exceptionally great month and have a lot of excess income, stay the course and only pay yourself your monthly paycheck amount. The extra money will be saved for a normal paycheck in any future months where things are a bit slow.

Personal savings or business checking: After you pay yourself, any extra money should stay in your business checking to continue building that buffer. Once you have 3 to 6 months of expenses covered with the buffer you can begin to funnel any excess money towards other savings goals, like a down payment on a house.

As you get more experience with this system you can make adjustments that work for you. You may have a better estimate of what percentage of your income you need to withhold for taxes or you may want to change the retirement savings based on personal goals. Adapt this formula to work for you.

To give a quick illustration of what this could look like, take a look at the sample monthly income below:

Month 1: $5,000 income

Tax account: 30% of income, or $1500

Retirement account: 10% of income, or $500

Personal paycheck: $2,500 (your pre-determined, steady paycheck each month)

Remaining: $500 to remain as a buffer or to allocate toward personal savings

 

Month 2: $10,000 income

Tax account: 30% of income, or $3,000

Retirement account: 10% of income, or $1,000

Personal paycheck: $2,500 (your pre-determined, steady paycheck each month)

Remaining: $3,500 to remain as a buffer or to allocate towards personal savings

 

Month 3: $2,000 income

Tax account: 30% of income, or $600

Retirement account: 10% of income, or $200

Personal paycheck: $2,500 (your pre-determined, steady paycheck each month)

Remaining: -$1,300, which is covered by your buffer

Though you had a rough month 3, you can still pay yourself a consistent paycheck. You've built up a buffer from months where your income was higher and can minimize your fear of running out of money and not getting the rent paid this month. This may seem like a lot of work up front, and it is. But once you get this right it will free up a lot of time and unneeded anxiety so you can focus on more important things—you know, like running and growing your business.

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Credits

Erica Gellerman #theeverygirl

Erica Gellerman

Finance Editor

Erica Gellerman is a small business strategy and finance expert who helps entrepreneurs create thriving, profitable businesses. She has an MBA in Market Strategy from Duke University, The Fuqua School of Business, and is a California CPA.