The Ups and Downs of Variable Income for Business Owners
Are you a business owner, self-employed, a freelancer, or commission-based employee?
Then you know the dilemma of living on and budgeting with uneven income.
Long-term planning can seem like a challenge when income varies from month to month or year to year. About forty percent of our clients at Bridge Financial Planning, LLC are business owners who face the special challenge of irregular incomes. Although there are specific difficulties that accompany a variable income, there are also ways to turn this challenge into the development of a financial plan that works FOR YOU instead of against you.
The first step is to know your bottom line. Project your future income for this year based on the lowest income month from the previous year. (If you are new to your job, you may have to use estimates until you have been working for a period – and rely on your business start-up funding.) Projecting next year’s income based on the lowest amount is a conservative approach for a growing business, but it helps be sure that low months don’t make your plans go off track. It protects you from the fear of forecasting too much income and can give you additional advantages as well. After all, the average can always go up!
The second step is the most laborious one, but well worth the effort. Make a list of all your expenses that are essential. Priorities would include food, shelter, clothing, transportation, debt repayment, and items like insurance that may be billed quarterly. Then list your discretionary expenses. If you are not sure what they look like, take inventory of your last credit card bill or bank statement (which could be eye-opening!).
Essential expenses + discretionary expenses would become your “salary” for the month, after any business expenses you might have. If the amount is more than your projected monthly income, then you are spending more than you are earning and you will need to cut some of your discretionary until your earnings are higher. The salary amount can be separated into an account specifically for your personal monthly expenses, and any overage can be set aside and deposited to an account that would be used to offset any lower-than-anticipated income months. When this process is used correctly, from time to time you will be able to take a bonus from the accumulated savings account!
Imagine how freeing it would be to know your necessary expenses are covered each month and still be building a surplus for leaner months. The goal is to put yourself in a position where you make the choices about your money that are good for you and your family, instead of letting the money control your choices.
Even though an unpredictable income can be hard to navigate, you may find that spending the time necessary to make it work for you will allow you to focus on more important things. In fact, taking the time to allow a CFP® professional to develop a comprehensive financial plan that is unique to your situation might be one of the best resourceful, time-saving, stress-saving moves you can make this year.