Guide to managing your finances as a freelancer

A-Z Guide to Managing your Finances as a Freelancer

Keeping up with client work is usually top of mind as a freelancer. Indeed, client satisfaction is critical. However, managing your money is also vitally important. When you are self-employed, you face significant financial risks such as taxes, planning for savings, and more. Use this multi-step guide to refresh your freelancer finances.

A-Z Guide to Managing Your Finances as a Freelancer

1. Review your company’s structure

Depending on where you live, you have several choices as a freelance business owner. Each business structure provides certain advantages and disadvantages. For example, setting up a corporation may give you the option to pay yourself dividends which may be taxed at a lower rate.

To keep life simple, let’s use the $100,000 rule to guide your freelance business structure decision-making.

Business Structure For A New Freelance Business:

If your freelance business generated less than $100,000 in revenue last year, use a simple business structure like a sole proprietorship. A sole proprietorship is simple and inexpensive to set up in most places. For example, establishing a sole proprietorship in New York State costs about $25. In most cases, you can set up this type of business structure independently. With a sole proprietorship, you carry out business under your personal name (e.g., “Jane Smith Graphic Design”). When your revenue is $100,000 or less, the administrative costs of other business structures may not make sense.

Business Structure For A Freelancer Earning Over $100,000:

On the other hand, when your business generates over $100,000 in revenue, there is some value in looking at other business structures. For instance, you may decide to establish an LLC or a corporation. When you set up a corporation, there are certain tax advantages. However, establishing a corporation takes time and money. The cost to establish an LLC or corporation varies by location, ranging between $500 to $1500 in the United States.

Remember Business Risk

There is one exception to the above rule of thumb: risk. If you are concerned about the risk of being sued in business, setting up a corporation may be helpful. For example, a freelancer who focuses on cybersecurity consulting could sue a client if the client ends up suffering an attack. Without the protection of a corporation or insurance, the freelancer might end up losing their assets like their home in a lawsuit! In this situation, protecting your personal assets by using a corporation can help. A cybersecurity consultant might also want to purchase business insurance for additional protection.

If you still have questions or concerns about your business structure, contact a qualified accountant with expertise in small business matters for further tips. As your business grows and evolves, revisit the question of business structure annually.

To summarize the advantages and disadvantages of the most popular business structures, see the table below.

Business StructureAdvantagesDisadvantages
Sole Proprietorship-Fast and inexpensive to set up

-Ideal for a 1 person freelance business

-No tax advantages

-No liability protection

LLC-Limits liability for owners

-Privacy protection

-No ownership restrictions

-Tax burden may be higher than corporations in some cases

-Administrative effort to establish the company

Corporation-Personal liability protection for the owners

-Tax benefits (e.g. employment income vs dividends)

-The most expensive type of business structure to set up. 

-Annual administrative requirements (e.g. taxes and board meetings

2. Measuring your freelance income

Once you have your business structure in place, it is essential to measure your freelance income. There are a few different ways to measure your income.

  • Cash Flow and Accounts Receivable Report

Sending out invoices to clients is exciting! Yet, your business could be in serious trouble if your clients take a long time to pay their bills. To minimize problems, keep track of your cash flow (i.e., the money that comes into your bank account). In addition, monitor your unpaid invoices (i.e., accounts receivable). If an invoice has not been paid in 30 days, send clients follow-up reminders. If clients find it difficult to pay you, consider switching to an easier-to-use invoice platform like CheckYa.

  • Monthly Income Report

Each month, review your total revenue and expenses generated in your business. In addition, compare your monthly income to last month and the same month last year. Over time, you will better understand your business income patterns. You might notice that your business has a slow period over the summer months. With that insight, you can better plan your expenses.

  • Top Clients Income Report

Create a report of the revenue you earn from each client. You will probably find that the 80/20 principle applies to 20% of your clients, generating most of your income. You can decide which clients to focus on next based on this analysis. If any single client makes up more than 50% of your revenue, take action! Relying on a single large client puts your business at risk if that client suddenly decides to end their direction.

For more insight on using the 80/20 principle to guide your business growth, read “80/20 Sales and Marketing: The Definitive Guide to Working Less and Making More” by Perry Marshall.

  • Profit & Loss Statement

A profit and loss statement (also known as an income statement) is also helpful for the final type of freelancer finance report. Creating a profit and loss statement can help you estimate how much income tax you have to pay. An income statement also helps you track business revenue and expenses in a single place. As your business grows in complexity, you may find it helpful to work with an accountant to create financial reports.

Use an accounting or bookkeeping software tool to simplify your freelance finances. For further guidance on setting your pricing refer to: How To Charge Your Freelance Clients?

3. Changing your freelance prices effectively

As you develop your expertise as a freelancer, your freelance rates should change as well. For a comprehensive guide on setting your prices, see our guide: How To Charge Your Freelance Clients?. By using that guide, there’s a good chance that you will decide to increase your rates. There are a few different methods you can use to boost your freelance rates.

Increase your prices with new clients:

The easiest way to increase your prices is to offer your new prices to new clients. For example, if you created WordPress websites for $5,000 last year, you may increase the price to $10,000 on your following client proposal. New clients will probably not know or care how much you charged other clients. They only want to know that you can solve their problem effectively.

Increase prices with current clients:

Increasing prices with your current clients is also worth considering. Think about all of the companies you interact with in your personal life. Most of those companies tend to increase their prices over time. To a degree, your clients will expect occasional price increases.

That said, there are two kinds of price increases you may offer. First, you may apply a slight 5-10% increase on your current services. Such an increase is reasonable to keep up with inflation. Provide your clients with reasonable advance notice (e.g., 30 days) and apply the higher prices.

The second type of price increase requires more thought and potentially much higher rewards. If you reinvent how you offer and package your services, you can price your services differently. For example, you might decide to change from charging a flat hourly rate to a day rate or weekly rate. In this case, you can offer different pricing.

Finally, keep in mind that you may lose some clients when increasing your prices. If a current client refuses to pay your higher prices, you have to decide whether you will keep working with them. Don’t let a fear of losing clients keep you back from increasing your prices! Every year, your skills are getting better, and the cost of living goes up as well. In 2021 alone, the inflation rate in the United States alone went up approximately 6.8%, the highest since the 1980s. Therefore, increasing your prices by at least 6% is reasonable. If you do not increase prices to keep up with inflation, you effectively reduce your income over time.

4. Managing your business expenses (short term and long term)

As a freelance business owner, you also need to manage your expenses. There are two kinds of expenses to forecast so that you minimize surprises. Note that taxes are a critical expense, and they will be covered below

Short Term Business Expenses:

In running your business, you will probably have a variety of monthly expenses. These expenses are relatively easy to plan for, especially in the case of recurring subscriptions. Use these tips to manage short-term expenses effectively.

  • File your expense receipts.

Save receipts and invoices for all of the subscriptions you use for your business. Some accounting apps like Freshbooks let you save a copy of the receipt directly into the software.

  •  Put expenses to the test.

It is easy to sign up for services, software, and tools that have the potential to help you grow your freelance business. For example, you might purchase access to a monthly coaching service to get expert advice. That expense is worthwhile if you use the service to ask questions and improve your business. However, consider canceling the service if you can’t remember the last time you attended a coaching call.

  •  Review personal expenses for business use.

Your personal expenses may be eligible for a tax deduction in some cases. For example, the IRS lets you “deduct certain expenses for the part of your home that you use for business.” Talk to an accountant for advice to make sure you follow the tax rules in your area.

Long Term Business Expenses:

Less experienced freelancer business owners are often surprised by less frequent business expenses. For example, you probably have a laptop that you use every day. It is wise to plan to replace that laptop. According to Business News Daily, the average life expectancy of a laptop computer is 3-5 years. If you have already had a laptop for several years, start setting aside money now – even if it is just $100 per month – for a replacement. You may want to apply the same process to your smartphone if you rely on it for business.

To find other long-term business expenses, review your business credit card and bank statements after being in business for a year. Look for significant expenses that happen once per year. For example, you might pay for business software licenses annually. You may have a coworking cost as well.

5. Keeping up with taxes as a freelancer

New freelance business owners are often surprised by the taxes they have to pay. Let’s use the self-employed calculator as an illustration.

Let’s say you earn $100,000 in self-employment income in 2021. According to the calculator, you would have the following payments:

  • Tax Amount: $15,300
  • Social Security Portion: $12,400
  • Medicare Portion: $2900
  • Self-Employment Tax Rate: 15.30%

The above example is a simple tax situation. You may have additional taxes to pay based on where you live. To determine the specific taxes you have to pay, it is helpful to make an appointment with an accountant. Bring some of the financial reports mentioned earlier like your profit and loss statement, to make the most of that consultation.

Let’s say your accountant tells you to set aside 25% of your freelance revenue for taxes for planning purposes. To put that advice into action, use the following tips.

  • Set up a separate bank account for tax payments.

Every time you receive a payment from a client, put 25% of your revenue into this account so that you will not be tempted to spend it.

  •  Confirm your tax payment schedule

A salaried person might only need to think about taxes once per year. Life is a bit different as a freelance business owner. In the US, the IRS requires some people – including business owners – to pay quarterly estimated taxes. Specifically, use Form 1040-ES (estimated tax for individuals) as a starting point.

According to the IRS website, estimated tax payments are due for payment four times per year: April 15, June 15, September 15, and January 15. Make a note of these dates in your calendar, and make sure you pay on time.

  •  Keep tax records for seven years

As a rule of thumb, it is wise to keep tax-related records for seven years. This includes tax payments, business expense documentation, and revenues earned. IT is crucial to keep these documents on hand if the government audits you.

6. Creating a budget that works for you

As a freelance business owner, there are two aspects to budgeting. It would be best to have a budget for your business and your personal expenses.

Business Budget:

To develop your business budget, reflect on your short-term and long-term business expenses. In addition, it is also vital to identify fixed expenses (e.g., cell phone plans) and variable expenses (e.g., advertising or usage-based services).

To develop your business budget, track expenses across the following categories:

Fixed Expenses

  • Rent (or coworking expenses)
  • Internet access
  • Payroll (may also include the cost of a personal assistant)
  • Website hosting

Variable Expense

  • Consulting services
  • Digital advertising campaigns
  • Office supplies (e.g., art supplies for a graphic designer)
  • Usage-based software

Personal Expense Budget:

In budgeting, some people advocate for tracking every single expense. However, that level of discipline is usually not necessary. Instead, it is usually enough to build a budget on the 4-6 most essential items. According to Quicken, the most critical items in most personal budgets are housing, transportation, food, utilities, and insurance.

After you have covered the critical needs, see if you can allocate some funds for fun and leisure activities. If you don’t take some time for fun and relaxation, you may burn out!

7. Developing short term savings plan

Planning exclusively for short-term savings plans will only take you so far. You will probably face one-time expenses like replacing a car, laptop computer and saving up to attend a conference.

When you are first getting started, it is best to focus your short-term savings effort on two or three areas at most. For example, if you have an old laptop, research alternatives. You might decide to buy a MacBook Pro for approximately $1300. To buy that computer in six months, you would need to save $200 per month. Once you have enough money saved up, buy the laptop and make sure you keep all of the receipts.

8. Create a freelancer emergency fund

Many freelancers struggle with the feast and famine business cycle. It might look something like this…

In January, you ask for referrals, networking, and outreach. As a result, you are fully booked with client work in February (i.e., the freelance feast). You are booked solid with client projects through all of February and don’t spend any time on sales. Consequently, you end up without enough client work to do in March (i.e., the freelance famine). This rollercoaster of income is a common problem for many freelance business owners.

There are two ways to break out of the cycle of freelance feast and famine. First, make time to prospect for new business every week – even if you are very busy. Spending at least 30 minutes per workday on sales and business development activities can go a long toward preventing famine.

Second, you can build up a freelance emergency fund. This is important because you may need a certain amount of income each month (e.g., $5,000 per month), and your business may sometimes fall short. According to a survey of financial experts by Time, an emergency fund should cover between 1 to 6 months of living expenses.

Determining how much you should save in your emergency fund will depend on your circumstances. For example, you may have a spouse salaried in that position. In that situation, setting aside 1-3 months of expenses as an emergency fund may be reasonable. On the other hand, if you live alone and have suffered lean months in the past, it may be best to save up to six months of living expenses.

By the way, your emergency fund should be in a plain bank savings account. It is unwise to put your emergency fund savings into the stock market. Investing in the stock market, bonds, real estate, and other assets should be your focus for long-term investing.

9. Establish your retirement savings plan

You will not have an employer-paid pension or retirement plan as a freelance business owner. Instead, it is up to you to create and fund your retirement savings plan. Before opening an account, take some time to estimate your needs with a retirement calculator.

For example, we ran the numbers with the Nerd Wallet retirement calculator based on the following:

  • Current Age: 30
  • Age of retirement: 65
  • Annual household income: $100,000
  • Annual retirement savings: 10%
  • Current retirement savings: $100,000
  • Expected income increase: 2%
  • Income required at retirement: 90
  • Years of retirement income: 35

Based on the above calculations, the plan would provide significant retirement income until age 79. Therefore, it may be wise to consider increasing your retirement savings, changing your retirement age, or making other changes. Consider meeting with a certified financial planner for retirement advice specific to your situation. You can verify a financial planner’s credentials using the following website: CFP Board.

Tip: When forecasting your retirement income needs, take note of other sources of retirement income. According to US News, the average monthly Social Security benefit in the US is $1657 (i.e., about $20,000 per year).

Use The Right Tools To Manage Your Freelance Finances

Managing your finances as a freelancer takes time and careful thought. Fortunately, some tools make the whole process easier. 

That’s not all. You also have options for optimizing the transaction fee. With CheckYa, you have the option to split the transaction fee with your client. You can also ask the client to cover the transaction fee. These fee options make a big difference as you start to charge higher fees.

With CheckYa, you can send unlimited invoices to as many clients as you like. Click here to sign up for CheckYa.

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