New freelancers and business owners have a long row to hoe. The learning curve can be shockingly steep in the beginning. Getting control of the finances is a big step in creating long-term success, but if you go about it the way you did as an employee you’ll run into problems. Freelancers are very prone to running into financial troubles because they didn’t see what was coming.
The Tax Problem
Taxes can crush an unprepared business owner. Let’s assume if you’re reading this that you’re an American freelancer just starting out. Everything is fresh and exciting. You’re getting your first clients and your first payments. They look great on paper. There are no tax deductions! But you know you have to pay taxes so you set a little aside based on your old paystubs. That should be enough, right?
Wrong, wrong, wrong. Your old boss may have been a jerk, but the reason he got to treat you like one is that he was secretly paying half of your taxes. Specifically, they pay half of the taxes taken out for Social Security and Medicare payments. These get lumped into a special Self Employment tax when tax time come around. By paying that extra share along with regular income tax withholding to the government, they got special rights as an employer over you.
Getting hit with a giant tax bill can blow out all your profits and put you in debt with the government. You do not want an IRS debt. They do not play around with their payment plans or the interest payments. So, rule one of successful freelancing budgeting is to set aside a quarter to a third of your income for taxes.
You will also want to hire a tax professional to help you keep your paperwork in order and to take advantage of deductions. Deductions are one of the hidden benefits of self-employment. Your CO at AND CO can help out with keeping track of the deductibles and hidden jewels in self-employment. You may have to pay more, but you can deduct quite a lot!
After your first year of freelancing, if you paid over $1000 in taxes, you will want to start paying quarterly payments to avoid a penalty. If you’re already used to setting money aside for taxes, this is no big deal and your accountant can do it for you.
Speaking of accounting, you should also take some time to invest in some proper bookkeeping and invoicing software. AND CO can handle both of these tasks for you, as well as keep track of your expenses. Your accountant will thank you.
The other thing that can destroy a freelancer is learning how to handle irregular income. Employment offers a steady paycheck. Freelancing does not. The common phrase is that the freelancing life is “feast or famine”. That’s why one of the first things you should do is to build a buffer.
A buffer is extra money that you put aside for next month’s bills. Finding out much you need is relatively easy. Write down your average monthly expenses for everything you need to keep yourself alive and total it up. Mint.com has some excellent tools to help you figure this out if you’re willing to dig through all the data and categorize it. Total up the amounts and that’s your buffer target. You need to save up that much into your account, minimum, as a separate expense.
Once this buffer is filled, it’s time to put it into action. At the start of the month, pay your bills from the buffer. Replenish the buffer from what you earn over the course of that month. If you have a dry month, you’ll have enough in your account that you can focus on marketing without panicking about paying your rent.
Of course, one month is a bare minimum. If you can build it out to two months or even six months, that’s even better. The larger your buffer is, the easier it is to rest easy when things get slow. It’s also much easier to take a vacation without worrying that your business is going to fall apart around your ears.
How Will I Get Enough Clients?
Now, if you’re a new freelancer reading this, you may be in a bit of a panic. You might only have enough clients to just cover your expenses right now. There’s not enough money coming in to set aside for taxes and to start building a buffer.
There’s a reason that the early days of a business are often lean times. New business owners often learn very fast which expenses are really essential. You may have to cancel that Netflix account and stop eating out so much. You might have to put in extra hours hustling for new clients. You might even forget when the last time you worked an eight-hour day was.
I can’t tell you the best way to get enough clients. That’s entirely dependent on the type of business you have. But what you can do is to understand how freelancers succeed in your niche and in general. The best way to succeed is to follow the examples of other successful people.
One site we can recommend is Freelancer’s Union. This is a great place to learn about how to set up a solid freelancing business that gets paid honest rates. Unfortunately, there are a lot of clients that try to take advantage of freelancers. You could be undercharging for your work, or think that no one would ever pay you what the “real” rates are. They could also try to squeeze free work from you, or never pay. You should definitely dive into that site and learn about these things so you can start avoiding bad clients and know how to score good ones.
The great thing about the freelancing boom that’s happening is that there is plenty of work out there. The pool isn’t so small that helping another freelancer get success is going to impact the bottom line. Many successful freelancers turn their skills towards helping new freelancers get off the ground. Take advantage of these programs, even if they cost you a little. Business education is a deductible expense.
If you are struggling with money in your freelancing career, or if you’re new to it and think it’s going well, you should take a moment and ask yourself if you’re really in the clear. Is your tax situation in order? Do you have a buffer? Are you following the best practices for your freelancing niche? If not, it’s time to hit the books so you can put a solid foundation under your business.