Budgeting for Self-Employed: 9 Tips to Master Your Finances

Budgeting for self-employed professionals is a must-have skill for anyone who wants to have a successful, long-term business. It involves the ability to plan and manage your efforts and finances to overcome income volatility and maintain the financial and operational health of your business.

This article explores the key tactics, strategies, and frameworks anyone should know when learning about self-employment budgeting. By the end of it, you’ll be prepared to take control of your finances and elevate your business to the next level.

Key Takeaways

• Budgeting for self-employed individuals involves accounting for irregular income streams and acknowledging the actual costs of running a business, like taxes and self-funded benefits.
• You should establish a self-employed budget framework by having a profit-first approach, a hierarchy of expenses, and an emergency fund.
• When planning taxes, you should regularly pay quarterly amounts, maximize deductions, and leverage tax-advantaged retirement and health plans.
• Good financial habits for self-employment include regular budget reviews, tax and savings automation, and continuous learning about finances.

The Self-Employment Income Reality Check

Before entering the realm of self-employment, you need to be aware of the biggest changes compared to traditional employment. Being familiar with the differences between these two can help you avoid unwelcome surprises when you start running your business and budgeting for self-employment.

So, let’s see what challenges being self-employed entails when compared to being a traditional employee:

#1. Managing Irregular Income Streams

One of the most significant differences between traditional workers and self-employed professionals is the regularity of income. While typical employees can expect a steady paycheck at established intervals (e.g., monthly pay or biweekly pay), self-employed individuals can experience significant fluctuations from one paycheck to the next.

Inconsistent revenue patterns create difficulties when trying to forecast and use a budget planner. That’s why it’s important to create income projections based on several months or even a year. This can help you create a baseline for further calculations, akin to a home budget.

On top of that, you can leverage income smoothing techniques to enhance your financial stability and make irregular income budgeting easier. For instance, you can set aside a percentage of earnings during the good months to cover shortcomings during leaner ones.

#2. The True Cost of Being Your Own Boss

Being your own boss comes with hidden expenses that traditional employees don’t face.

For starters, when budgeting for self-employment, professionals need to consider various operational costs. This includes the cost of equipment and software, marketing, utilities, professional insurance, continuous learning and development, and so on.

Apart from that, there are the benefits, like health insurance, disability and life insurance, retirement funds, and so on. In many cases, employers provide these to employees, while self-employed professionals need to fund these on their own.

However, the biggest cost of being your own boss is the taxes for self-employed individuals. While employers withhold taxes for their employees, business owners need to cover the entire amount of federal income tax, Social Security, and Medicare taxes. Paying both the employee and employer portions reduces their take-home pay.

#3. Separating Professional and Personal

To set a strong foundation for a successful professional and personal life, you need to separate your finances.

Your first step should be to set up multiple bank accounts and distinct systems. You should have a dedicated checking account for all your business-related income and expenses. This should be completely separate from your personal account, where you’ll receive your salary and spend money on everyday things.

This separation makes budgeting easier and simplifies tax preparation. As your business grows, you should consider transitioning to a formal business structure, like an LLC or an S-Corp.

They offer many benefits (e.g., liability protection) and room for growth, but come with additional legal and tax challenges, so you should research all the options thoroughly before transitioning.

Building Your Self-Employed Budget Framework

Having a robust self-employed budget framework is essential for your success. It sets the stage for your future financial decisions and helps you stay on track and remain stable even during periods of income volatility.

Here’s how to build yours:

#1. Employ the Profit-First Approach

The profit-first approach was popularized by Mike Michalowicz’s book, which switched focus from expenses to profit. The traditional accounting formula (Sales - Expenses = Profit) prioritizes expenses and leaves the rest for profit. However, the innovative mindset sets aside a percentage of every sale to profit first.

A good way to implement this system is to create several separate bank accounts (e.g., one for income, one for paycheck, one for taxes, etc.). That way, once you receive income, you can allocate portions to dedicated accounts based on your calculations.

If you stick to this formula, you can establish a regular “paycheck” for yourself, even during high-income fluctuations. This can make your finances more predictable, allowing you to budget for longer periods.

#2. Create Your Essential Expense Hierarchy

After focusing on the profit and your compensation, you want to create a hierarchy of the essential expenses for your business and personal finances. To do this, list the expected expenses and sort them by importance.

For example, in addition to taxes for freelancers and business owners, some of the essential expenses may include the costs of software and tools, contractor payments, various loans, and so on.

With personal finances, you can focus on housing, food, utilities, transport, and similar expenses. You should monitor your costs to make adjustments and decide whether to add to the budget or cut.

Having a structured approach and outlining how much each expense takes further contributes to your budgeting and forecasting. This is particularly important when navigating lean months and periods of reduced revenue.

#3. Establish an Emergency Fund

Making an emergency fund can be one of the most useful things you can do for yourself as a self-employed individual. Considering the uncertainty and financial volatility you can face, including various obstacles, unexpected business roadblocks, and other crises, having an emergency buffer is a great safety net.

Depending on your business and circumstances, you should have between three and six months' worth of essential expenses covered with the emergency buffer. If your business takes off and becomes more profitable, you can increase the emergency fund to cover you for up to a year.

These funds should be easily accessible in cases of emergency, giving you enough leeway to weather the storm and overcome a particularly rough period, or even start a new business. The key is to regularly contribute to this fund until you’ve reached your target goal and only use it when absolutely necessary.

Tax Planning Strategies for the Self-Employed

Handling taxes is one of the most important aspects of being self-employed, and knowing how to budget money. Let’s explore the essential strategies to help you plan your taxes and avoid making mistakes.

#1. Estimate Taxes Quarterly

Compared to traditional employees who usually pay their taxes once a year, self-employed professionals often need to pay quarterly estimated taxes. You should use Form 1040-ES to calculate and pay your estimated tax on income not subject to withholding, including self-employment earnings.

Quarterly payments are typically due on April 15, June 15, September 15, and January 15 of the following year. Not paying your taxes by these dates or underpaying can result in penalties, even if you overpay the next time. That’s why you should make accurate estimates based on your gross income, tax deductions, and credits.

#2. Maximize Deductions Without Raising Red Flags

One of the benefits of being a self-employed professional is access to a range of business deductions you can take advantage of. These deductions lower your taxable income, ultimately reducing how much you have to pay when filing your taxes.

Some of the most common deductions include home office costs, business travel, professional development, software, advertising, client meals, and more. However, it’s important to know the limitations of these deductible expenses, as any attempts to abuse the system and have unusually high deductions can result in an IRS investigation and audits.

#3. Utilize Retirement and Tax-Advantaged Planning

While retirement planning typically isn’t the first thing that comes to mind for new business owners and self-employed professionals, it’s a vital long-term aspect of financial management. Since self-employed individuals don’t have access to employer-paid 401(k) plans, they need to set up and contribute to their own funds.

Tax-advantaged retirement plans, like Solo 401(k), SEP IRA, and SIMPLE IRA, allow self-employed individuals to contribute to their funds while reducing taxable income. That way, you get immediate benefits while simultaneously securing your future and retirement.

Creating Sustainable Financial Habits as a Solo Professional

Making robust budgetary frameworks and financial plans is only viable if you stick to them and create sustainable habits. Let’s explore the best habits that can help you prosper as a solo professional.

#1. Regularly Review Your Budget

Your budget isn’t a static aspect of your business, and you should regularly review and adjust it when the circumstances change.

For instance, while the rule of 50/30/20 is realistic for most businesses starting out (50% spent on needs, 30% on wants, and 20% on savings), you might find it does not work for your income. In that case, you can adjust the percentages accordingly until you find a ratio that fits your cash flow better.

You should make this a common practice and conduct a review periodically to maximize your financial efficiency.

#2. Automate Savings and Tax Payments

Once you decide how much you want to save and calculate estimated taxes for self-employed individuals, you should automate these processes. This makes it easier to stick to your plans and avoid making impulsive decisions to spend the money elsewhere.

Moreover, by automating these routine tasks, you save time and effort, which you can then spend on working and growing your business.

#3. Continuously Learn About Finances

Business finances (including tax laws, investment, and deduction opportunities) continuously change and evolve. Since you’re a self-employed individual and the CFO of your enterprise, you need to be on top of these changes to make your business more profitable and avoid making costly mistakes.

While you don’t have to be a tax expert, you need to have a solid grasp of the basic concepts, such as what you have to pay when self-employed or what zero-dollar budgeting is. This will allow you to make better decisions and enhance the financial stability of your efforts.

Take Control of Your Self-Employment Finances with Paystub.org

One of the best things you can do to take control of your finances is to enhance your record-keeping with Paystub.org. We designed an intuitive set of tools you can use to create various documents necessary to run a business.

Here are the key software builders we offer:

• Pay stub generator. Quickly and effortlessly generate professional pay stubs for your employees or to keep track of your finances.
• Invoice generator. Choose a template that matches your business, and craft professional invoices to get paid for the sold goods or provided services.
• Form W-2 generator. Generate Form W-2 to report wages paid and taxes withheld for your employees.
• Form 1099 generator. Create Form 1099 to report payments made to non-employees or sales of consumer products to a buyer for resale of at least $5,000.

Final Thoughts

Budgeting for self-employed professionals is a must-have skill to achieve long-term success and avoid making costly mistakes. Therefore, learning how to budget as a freelancer, independent contractor, or business owner can help you manage income instability and overcome lean months.

The concepts and strategies we discussed will give you a strong starting point and provide you with the habits necessary to succeed. However, you should remember that finances are an evolving aspect, so you should continuously learn and inform yourself to thrive in your efforts.

Budgeting for Self-Employed FAQ

#1. How much should I save for taxes when self-employed?

As a general rule, you should save between 25% and 30% of your net income for taxes when self-employed, as this should typically cover income and self-employment taxes. However, the percentage may vary based on your state and income, so you should always research for accurate estimates.

#2. Can I qualify for loans or mortgages when self-employed?

Yes, you can qualify for loans and mortgages when self-employed. The process can be more challenging than for traditional employees, though, as lenders will want proof of stable income. This can include a year or two of tax returns, profit and loss, or bank statements, etc.

#3. How do I budget for health insurance as a self-employed person?

To budget for health insurance as a self-employed person, you first research your options. You can go to HealthCare.gov or through private insurers, keeping an eye on premiums that can be a considerable expense. You should also look into tax-advantaged health savings accounts (HSAs) that offer triple tax advantages.

#4. What financial ratios should I monitor in my self-employed business?

Some of the most important financial ratios you should monitor in your self-employed business include profitability ratios. For example, gross margin and operating margin ratios tell you how much profit you make and how efficiently you use your assets.

#5. How do I price my services to ensure profitability after expenses?

Pricing your services to ensure profitability includes calculating your total expenses and billable hours. Then, you should add your profit goal to the expenses and divide that by your billable hours to get an hourly rate. In project-based work, calculate the time and resources needed before adding markup.