Disclaimer: I am not an accountant. This post describes my approach to finances as a freelancer and nothing more. It has worked well for me and I hope it works for you! For the difficult stuff, I recommend consulting a CPA for the hard stuff.
If you’re used to getting a paycheck, juggling your finances as a freelancer can be a little intimidating at first. Income is inconsistent, taxes aren’t taken care of for you, and you need to track your expenses to make sure you save every dollar you can when tax time rolls around. It took a little over a year for me to figure out a system where the mental overhead was low enough that I could follow it without difficulty.
In this post, I’ll outline some of the steps you should take when you first get started and then go through the approach I use to ensure that I don’t have any money worries.
Setting Up Your Accounts
Before you accept your first payment as a freelancer, you should set up separate business banking and credit card accounts. This makes it easy to keep your personal and business finances separate. This becomes very important when it comes time to pay taxes on your business income.
Getting business bank accounts set up is pretty easy. You need to register your business with the proper authorities in your jurisdiction (usually the Secretary of State’s office) and then bring your business registration certificate to the bank of your choice. You’ll want both a checking and savings account for your business (for reasons that will be explained in a moment).
Getting a business credit card is optional, but having one can be handy when you need to make a larger investment in your business then you can afford to do with your cash on hand. For example, you may need a new computer or need to license some software to perform work for a client.
I’ve found that credit card companies will send you unsolicited business account applications as soon as you register your business. My advice is to compare the terms of your available options and pick one. If you’re looking for a recommendation, I’ve had consistently great experiences with Capital One (now Spark Business).
Processing Business Income
If you’re doing business online, you’re probably going to be receiving payments in multiple forms. Some clients will pay via PayPal, others via credit card through a payment processor like Stripe, and some will insist on paying via paper check.
No matter how you receive your income, it should be moved immediately to your business checking account. Do not deposit business income into your personal accounts directly. If you do, you’ll lose the authoritative view of business income and expenses that your business accounts provide you.
Save 1/3 of Every Payment
Once your income is in your business checking account, my advice is to immediately move 1/3 of every payment you’ve received to your business savings account. Once you move that money to your savings account, consider it gone until the end of the year. In your mind, it might as well not exist.
This is a really, really conservative strategy, but it has consistently given me good results. Why are you saving this money?
First, a conservative saving strategy is good for your mental well being. While moving a full 1/3 of your income into savings may seem extreme, having this hard rule means you’ll spend less time thinking about money and more time working on and in your business. That should lead to more productive work in the long run (and in turn, more income).
Also, saving a full third of your income means, in general, you’ll never have to worry about having enough money to pay your taxes, whether estimated or actual. I’m not advocating paying a third of your income in estimated taxes, of course, but if you have a more successful year than you expect, you’ll be able to cover any amount due when you file at the end of the year.
Finally, by saving this much you’re bound to have a huge chunk of change left over after you pay any tax liability after filing. I like to think of this as my yearly bonus. Over the past few years, my wife and I have done different things with this bonus including going to Hawaii for a week long luxury vacation and bolstering our house savings as we prepare for home ownership.
Record Every Business Expense
If you’re freelancing, you are going to have business expenses. You need to host your website somewhere, buy software, buy hardware for testing, take clients out for coffee, and more. Every one of these things can be deducted on your tax return as long as you have appropriate documentation for them.
As such, you should record every business expense and pertinent details about it. Here’s the information I record:
- Category (rough, like “Dining” or “Advertising”)
- Description of how it applies to your business
Not everything is deductible, but recording everything and filtering out the chaff later is a pretty good approach, in my opinion.
Use My Spreadsheet!
There’s lots of ways to track your financials, including some awesome online services. I prefer to keep everything offline so I track all my data in an Excel sheet I’ve developed that gives me a good view of my income and expenses throughout the year. You can download my income and expenses worksheet if you’re interested in how I do things. A fair warning, there are a lot of calculations in the spreadsheet so it may take a minute or two to open.
The spreadsheet is easy to use. Enter your income on the “Income” worksheet, including date, amount of payment, and an optional description. The amount you should save will be calculated for you. Use the “Expenses” worksheet similarly. Enter every expense, its amount, and an optional category and description. The “Totals” will show you your income, savings, and expenses for each month and for the year to date. I added a “Per Day” calculation so you can compare your income directly to your previous years based on the elapsed days in the year so far.
If you want to change the amount you save from 1/3 to some other amount, feel free to edit the appropriate cell on the “Helpers” worksheet.
If you’ve got any questions about the spreadsheet or anything else, or if you have some ideas about how to manage a freelancer’s finances, let me know in the comments!