Written by: Iona Bain, personal finance journalist and broadcaster
Freelancing is booming in the UK. No wonder, when we have the freedom to create our own opportunities. And to manage our lives with no boss looking over our shoulder. But with potentially irregular client projects and income, it's why budgeting is important when you're self-employed.
I think the pursuit of financial freedom tends to puzzle us. And as a money journalist, I know how people can glaze over when I tell them what I do.
But let's face it, from new starters to veterans, freelancers need to be money-wise - even more than those in a day job. Whatever we are creating for clients, we first need to create a personal and business budget. Getting a grip on expenses, tax, spending and saving means we can avoid adding money stress – usually the worst - to our portfolio of lesser stresses.
Yes, budgeting is the answer, and it’s not the dark domain of accountants (though you may need a spreadsheet).
It’s the key to managing your financial wellbeing, even ahead of hunting for clients, agreeing contracts, meeting deadlines and chasing payments.
Personal and business budgeting gives you an overview of your dual life, it makes your money work harder and protects you against nasty surprises. It can reassure, throw up a red flag, and provide opportunities for a more sustainable lifestyle.
We all know a project or a payment can take longer than expected. But there’s no need to live on the edge even when times are rocky. Your bailiff-proof budgets will have built-in margins which mean the bills will be paid. And when times are rocking again, the ‘B’ word will give you the discipline you need to save and to invest in your future self.
So you don’t need a business degree or an accountant to tackle cash flow and rainy day funds. Enter the world of budgeting and you are simply signing up to:
Spending less than you earn not over a month but over a year
Putting cash aside not just for bills but for taxes and for saving
Creating a routine where you check-in with your money not once in a while but every week
As a freelancer you are your own top employee. Budgeting will show you how much you can afford to pay yourself. That’s peace of mind.
Budgeting made easier
There are two ways to budget. One is guesswork and on the hoof money management – the hard way. Then there is information-based budgeting - the easier way, especially when you can borrow some nifty digital tools.
Firstly, take time out to sit down patiently with a drink and your financial records, whether digital or old school, and a calculator. In the past year, what did you earn each month?
There will probably be variations, maybe dramatic ones. Scan the past year’s bank statements or settled invoices and make the best guess you can about the year ahead. A simple bar chart might act as a reminder of the likely lows – times when what’s coming in may not immediately cover what’s going out.
New freelancers, you will need a best guesstimate of earnings over the next year. Build in some caution. Oldies, resist the temptation to assume that last year’s big one-off contract will repeat. You can only be pleasantly surprised when it does.
Armed with that first set of numbers, brace yourself and move on to analysing your spending.
If you already use a banking app you have a head start, especially if it breaks down your spending (and your splurging) into categories. You can look at the details later, and for the moment exclude any payments into savings.
Matching up your monthly projected income with your expected outgoings will be tricky. Especially if you are starting out, and have to make new investments in equipment or subscriptions.
But breathe deeply, perhaps use a simple spreadsheet, and behold your core budget overview. Deducting spending from income creates a set of 12 magic numbers, which are your cash flow month by month across the year. Hopefully it’s positive. If not, there are, as the saying goes, lessons to be learned.
You could turn it into another bar-chart if the first one worked.
If you have recently made the break for freedom, you are also now fully responsible for your pension or long-term savings. As well as a rainy day (emergencies) fund and a sunny day (holiday) fund.
The point of the big reveal of your cash flow pattern is that you will see when in the year you may have more, or less, headroom for all types of saving.
Your core budget won’t be 100% accurate, inevitably, but hopefully it won’t be Mystic Meg. Remember it will have moving parts, which means revisiting and updating your spreadsheet. As with all data, quality in equals quality out.
The benefit of separate business and personal accounts and budgets
As a sole trader, it’s tempting to think that one of today’s all-singing bank accounts and apps can do everything for you, business or personal, with a few taps or clicks.
And if you are opting not to incorporate your venture as a plc, you don’t legally need a separate business bank account.
But for any freelancer, your business is just that - a business. So the way to go is separate accounts. You really don’t want to be mixing up your printer cartridges with your Netflix subscriptions, your IPSE sub with your gym membership. Besides, banks tend to frown on using a personal account for business and you might be flouting their Ts and Cs.
Your personal account will handle all your living expenses and bills. So this is where to keep your payments, preferably direct debits, for council tax, rent or mortgage, energy, broadband and insurance. Yes, if you are working mainly or partly from home, some of these costs will be tax deductible against your business income. But you can calculate those later. Paying them out of your personal account will help you maintain an overview of your core outgoings and remind you they are non-negotiable.
The newer app-based accounts do boast more functionality when it comes to budgeting tools, helping you keep track of spending in real time. Or you can use a standalone budgeting app like Money Dashboard or Emma to monitor exactly how that cash is disappearing.
Your business account will receive all your working income, but not personal payments such as benefits. It should be used to pay your business expenses, and so help you track anything related to your business for tax purposes, which will be a huge time-saver. (Was that lunch with a friend/client business or not?)
App-based business accounts are easy to open, can be operated on the go, and offer useful budgeting features but not overdrafts or loans. They may attract you with free
High street business bank accounts may be a bit pricier, with monthly fees and some other charges which you may bridle at after years of free banking. But they do offer face to face chats in a branch. To open one you may face a grilling – no, let's say a friendly interview - where you tell all about your business and its prospects. But that could be a useful exercise, having to test your business plan with a professional.
What if you need a loan some day, or even just a credit card for the business? Managing a business account properly will build your credit history and give access to borrowing.
Track your business expenses and personal spending
With your personal and business accounts in place, it’s time to move from the core budget, to the hard core budget. You need to drill down into your spending numbers and bring to the surface all the detail that can help you manage your mini financial empire.
Your historic spending habits are the raw material for creating your detailed budget.
The government website Money Helper has a budget planner which is scarily comprehensive. It illustrates all possible categories of personal expenditure in six areas:
finance & insurance
family & friends
Money Helper may feel like a spy lurking over your shoulder, but it enables you to project all future spending and choose weekly, monthly or annually. It can help you to concentrate on your spending habits, and where you might want to rein things in a bit.
The income section includes the full range of state benefits along with grants, and savings or investment income.
The household bills page means you won’t conveniently forget about your TV licence, boiler cover or home insurance.
If you run a car, big bills tend to come in once a year and are easy to overlook. Renewing your vehicle tax or insurance is not a shock emergency,
Assigning everything from your records will keep you busy, though you may think tracking down a pizza delivery and allocating it to ‘takeaways’ is a detail too far for you. If so, there are more streamlined planners such as this one, which you could use to model your own version.
You may want to test your budget against the 50-30-20 rule. This advises allotting:
50 percent of your income to baseline expenses (food and bills)
30 percent to ‘variable’ lifestyle costs and
20 percent to savings – whether they be short or long-term, or priority debt repayments. This calculator shows how it works.
The typical planning tool is not aimed at us freelancers, and does not recognise the small matters of business expenses and paying our tax. So you might want to devise your own expanded spreadsheet that you can easily update, creating a new budget for each month.
The core budget you originally created, with its bar chart of monthly ups and downs, will show you where the pinch points and purple patches may occur. But you could aim to pay yourself a regular ‘salary’ which will cover average outgoings, and a variable bonus to cover expensive months and/or to inject extra profits straight into a savings fund.
If it looks like your income is being squeezed, you should be able to dial up the ‘salary’ if necessary. If you can’t, this is why you need a fund for slow periods and rainy days. When you can afford to pay yourself a big bonus, don’t be tempted to blow it on extra treats, build financial security.
Of course freedom comes with the added responsibility of having to fund your own time off. While you’re in budgeting mode, think about building in your next break when work is liable to be quieter.
However you tackle it, what begins as an audit becomes your budget or forward forecast. The secret is to be honest and realistic. Include those takeaways and the horrific expected increase in your gas and electricity bill. Ignoring habits or liabilities won’t make them go away – make it a ‘no hiding place’ budget.
Budgeting for self-employment tax
As all veteran freelancers know, the price of freedom is eternal self-assessment.
And it will soon feel even more constant, what with Making Tax Digital and its new quarterly demands just over the horizon.
But it doesn’t pay to be over-gloomy. One new bank well-meaningly advises allowing up to 30 percent of your income to pay your tax bill, on the basis that your income tax rate is 20 percent and National Insurance 12 percent.
But you don’t need an accountant to tell you that everyone has a personal tax allowance. Which means we can earn currently £12,570 a year free of tax, which rather changes the maths.
A more useful rule of thumb may be that maximising your allowable business expenses, by knowing exactly what you are entitled to claim and keeping smart records, could reduce your taxable profit by up to 30 per cent.
HMRC has its own guides and sends out emails with links to videos on its YouTube channel. They include the official lowdown on topics such as simplified expenses, record-keeping, and your return.
The good news is that an awful lot of business expenses are tax-deductible, but you need to know which ones, and track them fully.
All spending related directly to your business should come out of your business account. Don’t start using it for your weekly shop.
But if you work at home, you can also claim part of your household bills, based on the proportions of time and space used for business purposes. For instance if one of your flat’s three rooms is your office, and you are working in it five days a week, you can claim one-third of your heating/lighting bill divided by five-sevenths.
But that’s not all. There are also your housing costs (rent or mortgage), your water bill, and of course the broadband connection and phones that are essential to intelligent life. Study hard and you can work out what HMRC will routinely allow you to claim.
Well of course your utility bills are being paid from your personal account, quite right. So why not create a budget heading for ‘business allowables’, and then divide those bills correctly as they land? That way your tracking of expenses will be less historic and more real-time. MTD will soon make that worthwhile.
Here is HMRC’s list of allowable expenses:
office costs, such as stationery or phone bills
travel costs including fuel, parking, train or bus fares
clothing expenses for example uniforms
staff costs either salaries or subcontractor costs
things you buy to sell on, such as stock or raw materials
financial costs insurance or bank charges
costs of your business premises heating, lighting, business rates
advertising or marketing, for example website costs
training courses related to your business such as refresher courses
You cannot claim expenses if you use the £1,000 tax-free ‘trading allowance’.
You also have capital allowances including an annual investment allowance which can offset spending on essential equipment such as laptops, phones, and cars. The rules are tricky so keep up the study, and good budgeting will prep you for MTD.
How to save money as a freelancer and create an emergency fund
Your working budget may include a monthly allocation to saving, based on your past efforts or the 20 per cent rule. Or you may exclude it until all the more fixed parts of your budget are pencilled in, so you can see how much headroom is left for savings each month.
However you do it, you need savings goals to get you out of bed in the morning. The smarter banking apps will magic up virtual pots which you can name and assign to a must-have, a holiday, or the less glamorous target of paying off a credit card debt.
But before the fun starts, two funds should be top of your wish-list. First is the pot needed to pay your tax bills. Second will be the famous rainy day fund, where you will ideally park three to six months worth of income. Typical money advice says this fund is for emergencies such as a boiler breakdown. But you may already have insurance for that.
For freelancers, the real emergency could be running out of work for a few weeks or longer, though you could consider an insurance back-stop in the shape of income protection.
Whatever you allocate to savings and pensions, building that emergency fund and keeping it topped up should be priority number one. Or perhaps, almost number one, depending on your tax fund, your debt position, and possibly your energy bill credit at the moment.
But long-term savings – that’s pensions and their alternatives - matter too.
Another price of our freedom is that we miss out on an employer’s pension contribution, and building a future fund is all down to us. It’s easy to think putting it off doesn’t matter. The pensions industry always reminds us that the sooner we start the better. But when we’re desperately saving for a house, building a business, or simply paying off debt, then putting a pension off may be unavoidable.
So go for it as soon as you can. It’s easy to open a personal pension, it’s a much more transparent market these days, and easy to pick a plan that won’t charge you too much. So research the market and find a low-cost provider with good credentials.
Penfold is a powerful, flexible pension recommended by IPSE that’s tailor-made for the self-employed.
A valuable alternative or parallel strategy is to open a Lifetime Individual Savings Account (LISA). It’s aimed at helping first-time buyers save for a home, but it doubles as a long-term savings vehicle for anyone aged 18 to 39. The big attraction is the 25% bonus paid by the government every year on savings of up to £4000 a year. It cannot be accessed until you are 60 without forfeiting the bonus and a 5% penalty on top. If you’re eligible, and know you can resist raiding the fund, it’s a must-have.
Of course there’s no point in diverting cash to savings if you’re not getting the best possible interest. By definition, you can’t lock up your rainy day fund for a year or more to get the best savings rates, as the financial weather can change at short notice.
But there is a competitive market out there among internet-based savings providers, building societies, and some banking apps, to offer the top rate at any given time. Beware temporary bonuses or withdrawal restrictions, but otherwise be prepared to move your savings to the highest bidders, as long as they are regulated by the Financial Services Compensation Scheme.
Finally, save on your essential personal or business needs with the IPSE Rewards platform. IPSE members can access a wide collection of rewards and savings that are available from some of the UK’s biggest brands.
Useful support and resources if you're struggling to budget as a freelancer
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