Freelance Accounting 101: How to Thrive When Payment is Irregular8 min read
Don’t you miss the simplicity that came with corporate life and a regular paycheck you could count on every two weeks?
Though your freelance earnings may end up being greater than what you could expect from a set rate of pay at a more traditional job, it can be hard to budget when dealing with net-30, net-60, and of course, delinquent payments.
So what’s a freelancer to do? Just like the more traditional employee, you should still work to set up systems for money management and freelance accounting, respective of an irregular cash flow.
Here’s what we recommend:
#1 Incorporate Your Business
My first year in business, I acted essentially as a sole proprietor, which is what you are also classified as if you haven’t taken any steps to incorporate your business into an official entity. But the benefits of incorporating your business are numerous and are necessary to set up finances when payment is irregular in your freelance business.
Did you know that incorporating your business:
- Reduces taxes regarding income that passes through your business. Acting as a sole proprietor subjects you to self-employment tax on all earnings.
- Creates “the corporate veil” which essentially separates business and personal assets. Translated for the uninitiated, this means that if your business gets sued, a disgruntled client can’t go after your personal assets in a settlement.
- Allows you to apply for an EIN.
Talk to your accountant and lawyer to figure out what specific structure (LLC, S Corp, C Corp, etc.) is best for the type of freelance business you operate. Don’t have these players in place just yet? Connect with your local small business association for free advice.
#2 Apply for an EIN
An EIN essentially acts as the social security number for your business. If you worry about privacy issues when submitting a W9 to a new client, using your business’s name and EIN means you can keep your social security number to yourself.
Applying for an EIN is actually an incredibly simple and free process that likely won’t require professional intervention. However, if you’re working with a service to incorporate your business, they may include this step in the amount you’re already paying them.
At any rate, you can apply for an EIN on the IRS website. Once you’ve got that number in hand (you’ll get access to it immediately after your application), you can then open a business bank account.
#3 Open Some Business Bank Accounts
If you haven’t already, you’ll want to open a business checking and business savings account. Here’s what you’ll be using those for, and how they contribute to setting up finances when payment is irregular.
When you incorporate, you’re essentially demonstrating that your business and personal finances are two distinct and separate entities. As we’ve discussed earlier, this separation is necessary for protecting personal assets in the circumstance of a lawsuit.
To make this distinction more clear, you’ll want to open a second checking account in addition to whatever you’re using for personal expenditures. This really needs to be a business checking account, to make it obvious as to which accounts suit what purposes.
Besides protecting your assets, opening a business bank account can be useful in understanding the true amount of money you have for personal expenses, and what you have for business expenses. Once established, make sure to re-route all income from clients (direct deposits, checks, etc.) to first land in this account.
From there, use your business account to:
- Pay yourself: Estimate a twice-monthly salary and set up an automatic transfer.
- Pay your business bills: Ideally, you’re also separating credit cards by use regarding business and personal purposes. Set an automatic payment to pay your business credit card from your business checking account.
- Send money to your tax account: This should be automatic, and once or multiple times amount depending on your cash flow. Don’t wait until the end of the year to pay taxes with the remainder of the balance available in your business checking account.
Open a Tax Savings Account
I’ll repeat – do not wait until the end of the year to set aside money for taxes.
Don’t trick yourself and keep your business bank account balance artificially high, hoping that it ends up being enough without truly knowing what you owe. In your first year of business, you don’t have to pay estimated taxes, and will instead send in a lump sum at the end of the fiscal year. Unfortunately, this can be more confusing than helpful to the new freelancer who hasn’t quite figured out all of these important freelance accounting rules quite yet.
As such, paying estimated quarterly taxes can actually be a bit of a relief, as they’re unlikely to be off by much regarding the final total due at year’s end (unless you’re growing at an extremely rapid rate). Sending infrequent smaller payments, instead of one big payment, results in less of a stressor when it comes to parting with money.
Do yourself a favor and overestimate your contribution to taxes in your first year.
This might mean saving anywhere between 20-33% of your income for taxes, depending on deductions and any tax breaks you’ll eventually claim. Better to be safe than sorry, and if there’s money left over in your tax account after paying last year’s taxes in April, consider it as a head start on what you’ll owe for the next year.
Alternatively, you might use any leftovers in your tax savings account as money to invest in retirement savings, which may also help to reduce your overall taxable income!
#4 Set up Automatic Transfers
The secret to freelance accounting is to automate the process as much as possible. In extremely high or low grossing months, dates and payment amounts may need to be adjusted. Regardless, having a structure in place reduces the amount of effort you’ll need to put towards these tasks.
Let’s take a look at the specific automatic transfers you’ll want to set up, and how a monthly schedule of transfers might look respective of each piece.
First, pay yourself like you would if you were in the corporate world. Give yourself a twice-monthly salary, based on your estimated personal spending. This will help you to avoid spending what looks like “extra” money hanging out in your business checking account, instead saving it for emergencies and other unexpected expenses. Keeping money “in the business” can also help reduce your personal income tax contributions, but you’ll want to talk to an accountant to figure out how to make this tactic work for you.
Save Your Money
From here, you’ll want to set up additional automatic transfers – to your retirement accounts, to savings, and other budget goals (like a vacation) or long-term responsibilities (mortgage, car payment, etc.) you have.
To give an example, once a month after an automatic transfer from my business checking account to my personal checking account, I transfer a portion of that total into a joint account that my boyfriend and I use for groceries, utilities, and other common expenses we share.
Timing is everything when it comes to setting up automatic investments, as you don’t want to accidentally overdraw from an account before it’s been funded from one of your other accounts!
Plan for Taxes
As previously stated, set up an automatic transfer from your business checking account to a business savings account with the goal of using this account only for paying taxes.
Set and Forget Credit Card Payments
In order for this to work, you have to be a responsible credit card user, so that’s the assumption I’m making before giving this advice.
Set automatic payments from your business and personal checking accounts to your business and personal credit cards. Use a tool like Mint to monitor spending and any irregular charges.
Besides this oversight, don’t trust yourself to always make payments on time. To avoid the ding that can end up really hurting your credit score, set up automatic payments on or before due dates.
Some credit cards have a set payment due date, but if you’re trying to rock your freelance accounting when payment is irregular, try calling your credit card company, and ask for a new payment date that lines up with all of your other automatic transfers.
Here’s what a sample timeline might look like for using automation to assist in freelance accounting:
A Month in Automatic Transfers
- 1st: Transfer 1st paycheck of the month from business checking to personal checking
- 2nd: Transfer portion of “paycheck” to joint checking and rent
- 7th: Transfer ½ of estimated tax payment from business checking to business savings
- 15th: Transfer 2nd paycheck of the month from business checking to personal checking
- 16th: Automatic payments for credit cards (business and personal)
- 16th: Transfer money to retirement/savings accounts
- 22nd: Transfer ½ of estimated tax payment from business checking to business savings
You’ll be amazed by how much of your freelance accounting gets taken care of without any need for intervention.
For best results, before setting up a series of automatic transfers, give your business checking account a month or two to propagate with money, since it all flows down from there.
Freelance Accounting 101: How to Thrive When Payment is Irregular
For additional resources regarding freelance accounting and how to handle irregular payments, consider reading the following books:
- I Will Teach You to Be Rich by Ramit Sethi (this article of his expands on the concepts covered here)
- The Money Book for Freelancers, Part-Timers, and the Self-Employed by Joseph D’Agnese and Denise Kiernan
How do you manage your own freelance accounting? Is there another tip you’d add to this list? Tweet your thoughts at @ANDCO, and we’ll share the best insights!