Budgeting for an unpredictable income
November 19, 2010 8:01 AM   Subscribe

I realized shortly after asking this question that I should have made it more directly about how to budget with an irregular, unpredictable (freelance) income.

I've read that you should take your lowest week and budget off of that, but in my case, that would be zero. I've also seen suggestions to take an you average monthly income and budget off of that, but it seems like you would need some base amount of funds in the bank so you would have enough to spend that average amount even in lean months; I don't.

In fact, I'm not sure I'm even making enough to meet my expenses, so that's another challenge, i.e., is it possible or sensible to budget before you're making enough money to being with?
posted by The Dutchman to Work & Money (5 answers total) 5 users marked this as a favorite
Yes, it is, because how else are you going to know how much you need to make? You need to start thinking about this as business finance, and not as personal finance. You need to budget your expenses and forecast your sales. If there is a shortfall, you need to either cut the budget or put a plan in place to generate more sales. You also need to track this stuff through the year to make sure you hit your targets.

If this is way over your head, you need to either find a friend or relative to help you for free, or you need to seriously reconsider being in business for yourself. As a businessperson, your balance sheet is the single most important thing you need to take care of before even looking for your first customer.
posted by bfranklin at 8:21 AM on November 19, 2010 [2 favorites]

You do. And you need to build that slush fund somehow.

I'm a freelancer. I have a detailed budget for all our expenses (I use You Need A Budget, which has been recommended elsewhere in the green). And I mean really detailed - it covers all the one-off expenses during the year, monthly costs, presents, holidays, money for repairs etc.

So I know exactly how much we need to cover our costs during an average month, and update this each month so it's accurate. Let's say that's £1000, for the sake of it.

I also know what the cost base for my business is, in as much detail, and the tax rates (personal and corporation) that affect me. So a simple calculation means I also know how much the business needs to gross each month, excluding VAT (sales tax). Let's say that's £1,400 a month. That gives me a minimum target for the business, on average, each month, so that personally, I stay in the black.

Since this varies wildly each month, I take out as much as I can from the business each month and pay that into one personal bank account. Then that account is what actually pays me each month: it automatically puts the minimum amount into our main bank account to cover our budgeted expenses. This slush fund is the buffer that smooths out variations in monthly income.

The detailed personal accounts, plus the same for business costs, drive my new business generation efforts so I know what I need to aim for, on average, to personally stay in the black and hopefully save some cash now and then, as well.

These two work together, so you need to sort your budget and somehow start building that slush fund.

And bfranklin's last paragraph is absolutely bang on target.
posted by dowcrag at 8:38 AM on November 19, 2010 [1 favorite]

I recommend this book. I have an irregular income too and the strategies from the book helped me be more responsible and in control of it, instead of just saying "Oh, well, who knows how much money I'll make next month anyway!"
posted by anotherthink at 8:50 AM on November 19, 2010

Best answer: In short: build your budget around your basic needs, not your income. Don't try to live on bread and water now, but set up a tight monthly budget that should cover reasonable minimal expenses while allowing you to put away enough money to cover periods of low or no income. Once you have enough padding, you can set up another fund to allow you to have a little more luxury in any given month.

Details: I'm a freelancer with a highly irregular income who has been budgeting successfully for a few years using two Excel files. One file tracks my actual and projected professional revenue (each clearly differentiated) so that I have an idea of my projected final revenue for the year and how much tax I have to pay on a quarterly and annual basis.

I also have a separate personal file with a worksheet for each month that covers several categories of expenses.

1. Fixed monthly costs (mortgage, insurance, RSPs, emergency fund, etc.). These are fixed amounts that are withdrawn from my bank account or designated credit card every month. The sheet uses different columns for cash versus credit card so I never lump those sums together.
2. Variable cash on hand (groceries, transit fare, etc.). This is the sum I let myself pull out from the bank each month. This amount varies with the type of budget I'm building that month (see below).
3. Fixed credit card payments. This shows the previous month's sum of scheduled credit card charges.
4. Variable credit card payments. This is the sum of any other credit card purchases that I have made the previous month. THE CREDIT CARD GETS PAID OFF IN FULL EVERY MONTH. I do not carry a revolving balance.
5. Variable monthly costs (phone, gas, hydro, etc.). These bills may or may not be the same every month, but because there is some variance, they are classified as variable.
6. Irregular cash reserves (house maintenance; dentist; clothing; bike maintenance, etc.). I put aside small designated amounts every month to have in hand for these non-monthly expenses. This is kept in my savings account.
7. Scheduled tax reserves: I charge 13% HST on services, so when I'm paid that amount, it goes to my business account immediately with no pain. I also set aside the money that will be paid quarterly towards my income tax. This amount will vary depending on my actual income, so I spend some time consulting with my business revenue spreadsheet trying to figure out my projected tax so that I have 25% or more available at each quarter. Unless I'm really broke (as I was in the first quarter of the year), I try to front load my taxes by using the most optimistic projection for my income so that I don't underpay any quarter and have to pay interest when I file.

How I make this work with an irregular income is to set up a bare bones budget, a screaming emergency budget, and a breathing space budget.

The bare bones budget (no more than 5 transit tokens a month for client meetings where the bike won't work, basic tv and cell phone service, cheap haircuts every 8 weeks, etc.) is the default. There's some relaxed spending built in to this -- some pub nights, some art supplies -- but it's structured to cover all costs, pay down old debt, and build the emergency fund.

The screaming emergency budget (not used yet, but waiting in reserve) strips out all non essentials: no cable tv, no meals out, etc. This is to be used if work disappears or I actually start tapping into my savings for more than x months. (Your x months may vary depending on the size of your emergency fund).

The breathing space budget (not yet used) will allow for a little more luxury, but it will kick in only when my emergency fund is large enough to cover 8-12 months of bare bones budgeting.
posted by maudlin at 8:54 AM on November 19, 2010 [1 favorite]

The Dutchman: "I've read that you should take your lowest week and budget off of that, but in my case, that would be zero. I've also seen suggestions to take an you average monthly income and budget off of that, but it seems like you would need some base amount of funds in the bank so you would have enough to spend that average amount even in lean months; I don't."

So what do you do in weeks (months) that you earn zero dollars, but still have to eat and sleep under a roof? Put it on the credit cards? What do you do when you don't have the minimum payment the following month?

You absolutely need to build that fund or find a reliable income. Think part time jobs, like library clerk. Budgets help you identify and reduce expenses, what you need is a method of reducing risk, aka the volatility of your income. Having a month or two of savings can smooth the income from high months into the low months.

What you might do, depending on how long you've been freelancing, is place how much you've made every pay period for the last few years into a histogram. That'll help you determine what your average income is, and how wide the possibilities are.
posted by pwnguin at 5:01 PM on November 19, 2010

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