• Finance

Setting Yourself Up for a Healthy Financial Future

Finances can be an overwhelming topic for anyone, but especially freelancers who are dealing with a potentially inconsistent income. You don’t need to be an accountant to keep your business running smoothly and set yourself up for a healthier financial future. All it takes is a bit of preparation and organization.

Separate your business and personal funds

Many freelancers use their personal bank accounts for business income, but it makes it far harder to sift through when tax season rolls around. Instead of going through each expense line by line, save yourself time and the risk of error and set up separate business and personal accounts.

It makes it easier to see what’s come in and gone out related to your business, and you can also prove the state of your business finances quickly and easily when needed. If you decide you want to incorporate your business into a Limited Liability Company (more on this later) you will be legally required to have a separate bank account, so it makes sense to do this now.

Put money aside for your future self

It’s not just your present bills and expenses you need to think about. Now you’re your own boss, you need to think about how you’ll fund your lifestyle in the future. Having a retirement strategy is important at any age, but the earlier you can start saving for later in life, the better off you’ll be financially when you choose to retire.

There are several options available for freelancers, from a Roth IRA or Traditional IRA to a SEP or Solo 401(k), so it can be worth sitting down with a financial advisor to determine which is the best option for you, your income and your financial goals. Whichever retirement plan you choose, however, make sure you set up automatic contributions each month so you know you’re saving consistently.

Determine if you’re a sole proprietor or an LLC

Two of the most common business structures are sole proprietorships and LLCs, or Limited Liability Companies. Each has its own pros and cons to think about, not least in terms of your finances.  

If you choose to be a Sole Proprietor, which many freelancers do, you can work straight away under your own name rather than a business name, so it’s much simpler and you don’t need to worry about any forms or fees to get started. Sole Proprietorship also comes with the added bonus of simplified tax filing, since you’ll pay tax on all your business net profits. But there are downsides to think about. Your personal assets are at risk with this business structure and you could find obtaining financing difficult, which makes it harder for you to scale your business.

As an LLC, you remove yourself from risk when it comes to personal liability for debts which gives you protection as an individual against commercial debts or lawsuits. It also makes it easier to obtain financing, as well as tax benefits via federal tax laws which allow for deductions of up to 20% of business income. Naturally, as an LLC, you have more expenses to pay for, including set-up fees and higher costs during tax filing season, and you’ll need to keep careful business records to maintain your limited liability protection.

Create a buffer fund

A buffer, or cash cushion as it’s sometimes called, is extra cash that you leave in your bank account to cover your core expenses when you have a lull in work or when you’re awaiting payment for an invoice. For example, say you earn $4,000 in gross profit one month, but you only need $2,000 to live on, and $500 in business expenses.

The money remaining can serve as your cash cushion so that in a later month when you don’t earn as much, you have enough to cover all of your expenses comfortably. Freelancers often have inconsistent income, so this buffer takes the pressure off. However, it’s worth having a separate emergency fund in place in addition to your cash cushion — an emergency fund is reserved for those larger expenses, such as your car breaking down or needing to take time off work for illness.

Invest in insurance

The right insurance can prevent the need for unplanned business spending, such as needing to replace your laptop at short notice, or more serious concerns such as legal action if you accidentally damage a client’s property when working.

Just as health insurance is essential to protect you if you become unwell, liability insurance can protect you in the event of an accident, and contents insurance will protect the devices and software you depend on for work. It may seem like a business expense you can skip, but the reality is that the protection it offers you as a business owner makes it highly worthwhile.

Know what your runway is

It;s a good idea as a freelancer to know what your runway is — that is, how much you need to stay afloat financially without extra money. This figure is the sum of how much you need to pay yourself plus how much you spend on your business each month. For example, if you pay yourself a monthly salary of $3,500 and you spend $1,500 on your business needs, that’s a total of $5,000. If you have $16,000 in savings, not including money put aside for taxes, you have just over 3 months’ runway to cover you before your money runs out.

This figure is important because it enables you to think more strategically about your finances and may highlight that you need to take on more clients, add an additional revenue stream or increase your rates to protect yourself and increase that runway figure.

There are so many advantages to being your own boss, but there’s no denying that the financial aspect of being a freelancer requires a little more care and attention than a full-time employee. Luckily, once you have the right systems in place, it’s just a matter of monitoring and maintaining them to keep yourself financially secure.

Annie Button Annie is a freelance writer based in the UK, specializing in business development, branding, digital marketing and HR. An English Lit grad, Annie has written for various online and print publications.