You made the leap. You’re a full-time freelancer. Each and every day belongs to you. And although you manage your schedule and your workload, you also manage your pay rate. So, how do you pay yourself?
Do you keep those paychecks coming every other week as if you were still with your former employer? Or do you skip paychecks and take distributions each time you get paid?
As with most aspects of your freelancing business, the specific answers to these questions will vary from freelancer to freelancer—but some basic principles should guide the methodology driving your pay. As long as you plan, structure, and track, you’ll be on the right path to paying yourself as a freelancer.
1. Estimate Your Freelance Revenue
When you worked for an employer, there was likely no shortage of meetings regarding revenue review and projections. While the boredom of such meetings might have been the driving factor behind you moving to full-time freelance work, you would be wise to borrow the overarching concepts of those meetings for application to your freelance business.
Freelance work comes in many shapes and sizes and estimating revenue may be an easy or an almost-impossible task, depending on the nature of your revenue. For instance, if you are a consultant, and you sign multi-year contracts with a three to five clients, estimating your revenue might be an easy exercise. However, if you are a freelance blogger counting on ad clicks for revenue generation, you are likely at the opposite end of the spectrum as the consultant.
To get started, you may want to set some revenue goals, and start working towards those goals, while tracking and adjusting your revenue expectations as the year goes on. Pretty soon, you will be able to look back at your performance, and use your past earnings to better estimate future revenue. Regardless of where your freelance business falls on this spectrum, estimating revenue is key to paying yourself, because the next three steps will reduce the amount of revenue available to pay yourself with.
2. Calculate Your Business Expenses
Whether your revenue generation might vary, you should have a strong sense of your expenses month to month. Most expenses—i.e. utilities, rent, business development costs, etc.— should remain consistent over the course of a year.
Additionally, you might have some one time expenses that pop up in the different stages of your freelance work. For instance, in the early days, you may have some up front capital investments, like a computer, office equipment and incorporation fees. At later stages, you may have some add-on expenses like travel costs for a conference, hiring subcontractor help or seasonal ad campaigns.
Whether the costs are predictable over time or one-off expenses, you should have an expectation of the costs to run your business. It’s critical to plan for costs of all sorts and ensure that you subtract the expenses from your estimated revenue before you decide how much to pay yourself.
3. Determine How Much You Want to Get Paid
The third step in paying yourself requires that you take an honest look at your personal needs and goals. You’ve already accounted for the expenses to be pulled out of your estimated revenue in steps one and two. Now, you need to determine what you need and desire from a personal income perspective.
In this step, it helps to divide yourself into two people:
- You, the business owner
- You, the employee
The employee side of you will want to bank as much personal income as possible. However, the business owner has the interest of the business to look after. You need to determine needs first, and then desires. Once you’ve determined your actual needs (e.g. mortgage/rent, food, utilities, etc.), then you can tack on the desires that reasonably allow you to leave enough revenue in the business to meet your business goals.
Some freelancers choose to minimize personal needs until the freelance business has grown to a particular size. Others elect to comfortably pay themselves from the get-go without ever setting a goal of growing the overall business into something larger. There’s no right or wrong answer, but answering the question, “What do I personally need from this freelance business?” is critical to finding the sweet spot.
4. Create a Reinvestment Strategy
What are your goals for the business? Do you want to grow and eventually hire others, or do you want to sustain a one-person business?
There’s no right or wrong answer here, other than the need to be clear about your goals. If reinvestment into your freelance business is necessary to meet your business goals, then you can’t pay yourself all the revenue that you earn.
This amount you reinvest could vary largely depending on your business. You may need to hire supplemental freelance workers. Perhaps you need to travel to more conferences to get the word out about your business. You may need to physically move to a new location that is more likely to attract new clients. There is an endless list of reinvestments that could benefit your freelance business. Just like the first three steps in planning, the key is to honestly evaluate the reinvestment needs and goals necessary to achieve your business expectations.
5. Separate Business and Personal Accounts
If you have been running your freelance business for a while, this may seem like a no-brainer. But for those who are just getting started, it’s highly likely that payment from your freelance work is going straight into your personal bank account.
Separating your business and personal accounts will help you in a number of ways. First, separating the two helps segment your business activity from your personal activity. Thinking back to step one, the various elements of planning are difficult to execute if your personal and business accounts are mixed. Delineating between personal expenses and business expenses is difficult to do if all of the expenses are coming out of the same account.
Imagine a Saturday afternoon run to the store. Maybe you pick up some pens, paper, and other office supplies for your freelance business. But you also need to get laundry detergent and some diapers for your family. You are left with one receipt, charged to one bank account, and now you have the onerous responsibility of itemizing the receipt between personal expenses and business expenses within your accounting methods for the business.
And if you decide to organize into an LLC or a corporation, there are certain rules you must follow in order to achieve the desired separation of risk between the company and you personally. Should a court be brought in to see if you have adequately delineated your business from your personal life and assets, one of the first considerations the court will make is whether you have commingled funds of your personal and business life. With a single account for business and person use, it’s hard to argue that you haven’t commingled funds.
6. Set Up a Payment Method
Now that you’ve created a separate bank account for your freelance business, and your clients are paying into that account, you need to set up the method by which you are going to pay yourself.
Modern banking gives you great flexibility when it comes to the how. You could certainly go old school and cut yourself a check from your business account, drafted to you personally, but that takes time and can certainly be avoided through one of the many payment options currently available. With auto-draft, payment platforms, direct deposits, and ACH transfers, setting up an automated payment method is definitely the suggested method to minimize the operations required to pay yourself.
If your freelance work doesn’t produce consistent revenue, you might not want to set up auto-payments yet. However, you can still sync up bank accounts. When it does come time to pay yourself, you can do so with the click of a button.
7. Determine the Payment Interval
Once your business and personal accounts are separated, and you’ve set up your payment method, you need to determine a payment interval.
Philanthropic consultant Christian Michael, told QuickBooks that he elected to maintain a two-week payment interval when he jumped from employee to full-time freelancer. For Christian, this ensured a consistent stream of income. However, he limited the two-week payments to the smallest amounts he could bear. After paying himself and taking care of his expenses, he was then able to pay himself a year-end bonus with some of the remaining freelance income.
Christian’s strategy works for him, but there is no single recipe for success when it comes to the frequency that you will pay yourself. The key is picking a method that fits your needs, and one that adjusts with you and your freelance business.
8. Track Your Revenue and Expenses Carefully
Perhaps the number one reason to track your payment activity is to ensure you can properly calculate your taxes.
Whether you freelance as a sole proprietor, LLC, corporation, or some other model, the tax man will come for his portion of your freelance revenue. As we’ve mentioned before, the method by which you calculate and report taxes vary depending on your business structure. Regardless of your freelance business structure, you can’t calculate, report, and pay your taxes correctly if you don’t track your expenses and payment. If you screw up your taxes, you expose yourself to suspicion from the IRS.
Tracking will also help adjust your planning and structuring. Your freelance work will not be the same next year as it is today. Your client base may grow, or shrink. You may be able to charge more in the future, or maybe you are charging too much today. Your expenses will evolve as your business strategy evolves.
Whether your freelance business is wildly successful, or requires you to make some personal sacrifices to get it up and running, you will inevitably need to adjust your plan and structure to meet both your business and personal goals. But, if you don’t track your expenses, and what you are paying yourself, there’s no effective way to adjust your plans and structure. The best way to plan for your future is to track your current.
Perhaps you, like many freelancers, made the leap to full-time freelance work to avoid the formality and mundane business operations associated with your former employment situation. In that case, the planning, structure, and tracking suggested in this post may be a turn off.
While the steps may take a little work in the beginning, most of the time intensive work is short lived, and modern tools like QuickBooks make the ongoing work a breeze. Further, the long term business benefits your freelance business will enjoy with minimal planning, structuring and tracking should encourage you to implement such a strategy in your plan to pay yourself.