My husband and I are small business owners, so our income fluctuates from month-to-month. Some people think that the self-employed cannot use a budget because of these kinds of income fluctuations, but Mr. Right-Click and I have been successfully using a monthly budget ever since we got married. Even when we don’t know the exact amount that will come in each month, the system we have in place allows us to set a rough budget and adjust it as needed as the actual checks start coming in. Today, I thought I’d list some of the tips I’ve gathered over the past few years of budgeting on a variable income. Budgeting makes your life easier, even if it takes you a while to get a feel for how it works best for your family.
- Figure out your baseline income based on months before. When you’re self-employed, the exact amount of your paycheck every month (or other pay period) is not always easy to estimate, but you can usually figure out a baseline number to guide your budget. When making up the budget each month, I use a baseline number that is low enough so that it’s highly unlikely that we will end up with less income than what is stated. The odds are that you have a rough idea of what this baseline income should be just by thinking about income from months that have come before, but if you don’t, a good way to figure it out is to look at past deposits and figure out an average for the past year or so to get a rough idea of what the minimum amount coming in is likely to be.
- Estimate your baseline need expenses. If you’re self-employed, this will actually be easier than estimating your income. Assuming that you are not in a “Four Walls” kind of situation, you should include things like food, debt payments, mortgage/rent, utilities, etc. in your baseline need expenses. Do not include emergency fund savings or other non-essential expenditures in this category. This number is just the basic number of money you need in order to get by each month, and hopefully it is already lower than the first number you estimated (the baseline income). If it’s not, then you will have to figure out some areas to cut, because banking on making more than that each month is just a recipe for anxiety and potential disaster.
- Estimate the flux categories of your budget. Flux categories are the budget areas that can shift up and down according to the specific number that is brought home. The Right-Click flux categories include: Mini’s 529 account, Emergency Fund savings, retirement savings, money that goes into the “hills and valleys fund” (more on this below), extra payments on student loans and the mortgage, household improvement items, gifts, etc. Flux items can be anything, really, provided you can let them go when money gets tight.
- Divide any windfalls you get into three categories: 1) save, 2) invest, and 3) spend. What about those times when you get more money than you expect? How can you keep yourself from using all of that extra cash on a new TV or the latest computer game? Well, you should treat all windfalls the same way, and decide how you will deal with them ahead of time. The way we deal with any extra windfalls at the Right-Click household is to devote most of the money to saving and investing, and some to spending. Some of you will ask why do we need the “spend” category, and the answer is that it is much easier to put the bulk of the money toward long-term goals if you let yourself spend some of it. For us, a small splurge goes a long way towards keeping us on track long-term.
- Bonuses should be treated as windfalls, rather than factored into the regular budget. Windfalls are not just reserved for those times that you inherit money or get more money back from your taxes than you expected. It also applies to when you make more money than you expect. On those months, you should use the windfall rule to divide up your money, paying particular attention to the “saving” category so that you can insulate yourself from those months where income is not so good.
- Speaking of months that aren’t so good, use a “hills and valleys” fund to plan for these. In order to cover “flux” categories on those months when you don’t make as much as you would like, you should have a “hills and valleys” fund set up to cover these expenses. Whenever you get a bonus, or a windfall, or if you just make a little bit more than you expect, it’s good to put a chunk of the money in the hills and valleys fund, and then leave it alone until you really need it. It not only will allow you to meet some expenses when times or tight, it will make you feel more secure about your overall financial picture, just knowing that it is there.
- Put 25% of your income away for taxes. You will have to adjust for the specifics of your income, but a good very rough estimate is that you should put aside about 25% of your business’ income each month to pay taxes. This is why having separate accounts for your business and your personal money is essential — without these separate accounts, it’s much more difficult to figure out what is gross income and what is take-home. When I get a paycheck, I put a percentage of it into a tax impound account so that when time comes to pay quarterly taxes, we have the money to do it. When in doubt, take out more money: it’s always better to have the IRS owing you money than the other way around.
- Pay big yearly expenses all at once wherever possible. This tip might be something that only applies to me, but I always feel better about the fluctuating nature of our income when I pay big premiums up front, rather than splitting them up over twelve months of the year. So if we have a surplus in our taxes account (like we did last year), I will take that and pay life insurance, homeowner’s insurance, earthquake and fire insurance, and car insurance premiums for the whole year all at once. It’s a small savings to do it this way over breaking it up into a monthly payment schedule, but mostly I do it for piece of mind. It’s nice to have a few less items to worry about each month.