Freelancer Finances: How Budgeting Affects Billing

So you’ve decided to launch a freelance career—or you’re already off and running with yours. Maybe it’s just a side gig or maybe you intend it to be your primary source of income.

Either way, one of the most important questions you’re likely to ask yourself is, “How much should I charge for my products and services?” Sounds like a simple question. But actually, it’s pretty complicated.

As a freelancer, billing for your work is intrinsically connected to budgeting for the other parts of your life. Before you can figure out what to bill, you have to quantify what it will cost for you to live comfortably. Let’s take a look at how to do both.

Thinking Long-Term from the Get-Go

Many people starting out in their freelance careers don’t have a firm grasp on what it costs to run an independent business. We’ve been there.

In the beginning, you’re excited to get every piece of business that comes your way. You’re focused on being competitively-priced because you certainly don’t want to lose out on a job. And particularly when gaining experience and building your client roster are your foremost goals, treating opportunities as loss leaders can make sense.

But remember that you’re establishing a pricing precedent when you quote your first project. Just like asking for a raise when you’re employed by a company, raising your prices as a freelancer can be challenging. So it makes sense for you to set a rate that you can live with for an extended period each time you establish a new client relationship.

Figuring Your Freelance Rate

We just used a key phrase: a rate you can live with. What does that mean? Certainly, you want to feel like you’re being paid what you’re worth. Working for less can be an emotional drag.

But focus, for the moment, on the more literal, mathematical meaning of the phrase. What does it actually cost you to live? You should also consider a corollary, strategic question: what will it cost you to remain competitive and grow your business? Freelance rates are determined, in large part, by what the market can bear.

Apply the 50-30-20 Rule

Financial experts have come up with a simple budgeting formula you may want to use when figuring your cost of living and the rates you’ll need to charge to maintain your lifestyle. It’s called the 50-30-20 rule. Here’s how it works:

  • Spend no more than 50% of what you earn on essential expenses. When you come up with a list of your essentials, rent, utilities, and food will doubtless be on it. But many beginning freelancers don’t take into account certain essentials that were previously provided by their employers. Health insurance is at the top of that list, but disability insurance should also be on your radar. As a freelancer, it’s all on you. A couple of weeks of missed work can decimate your budget for the month. Most importantly, be sure to account for income local, state, and federal income taxes. You should add an additional 25%-30% to your expense total. Set that money aside, perhaps even in a separate bank account, to make sure you’re prepared come tax time. Incidentally, as a freelancer, you may be required to pay taxes quarterly rather than annually as you did before you were self-employed.
  • While you’re counting up essential expenses, be sure to take into account your regular business expenses, including the professional and tech services you’ll need to keep your freelance venture humming along. These include the best internet service provider you can find and cybersecurity products like anti-virus and malware protection. You may even want to install a virtual private network to protect your clients’—and your own—privacy. You may also need to hire a tax professional when you open your own business, since filing as a freelancer can be more complicated than filing as an employee.
  • Discretionary expenses are the easiest part of your budget to control. Experts suggest you spend no more than 30% of your income on entertainment, travel, the latest fashions, and other things you can live without. If your essential expenses amount to more than 50% of your salary, it’s time to take a look at discretionary expenses and make cuts where you can. You might also pare down your list of “nice-to-haves” and use the money to start (or continue to fund) a retirement savings account.
  • The final—and absolutely critical—category of spending the 50-30-20 rule isn’t spending at all. It’s saving. It’s estimated that more than 40% of Americans don’t have an adequate emergency fund. How about you? People who don’t have an active savings plan often have to rely on high-interest credit cards to see them through common events like an unexpected medical bill. By saving 20% of your income each month, you can build up your fund pretty quickly. The money you save should be fully liquid. In other words you can spend it without suffering a financial penalty. You might want to stash it in a great high-yield savings account: one that earns you a higher-than-average interest rate.

Figuring Your Hourly Rate

Some clients prefer a firm project price from the outset. But even when billing by the project, you’ll need to figure your hourly rate to accurately prepare project quotes. The first step is to add up your monthly expenditures according to the 50-30-20 rule. Then decide how many hours you feel comfortable working each month and divide your expenses by that number. Do you have an hourly rate yet? Not quite.

Experienced freelancers know it’s important to build in a cushion. We suggest you add a minimum of 10% extra to your total expenses to account for bills that come in higher than expected or jobs that take longer than you’d hoped. Granted, you may not always be able to command your target hourly rate. But it’s important to set a standard against which you can judge each opportunity.

Consult a Financial Advisor

Financial advisors aren’t just for the rich and powerful. Some even specialize in helping gig workers achieve their financial goals. They can advise you on budgeting and managing the challenge of living with an inconsistent income. They can point you in the right direction when it comes to your insurance needs and retirement planning. And perhaps most importantly, they can help you develop a realistic tax strategy for keeping more of what you earn each year.

Gig workers bear the full brunt of paying social security tax because they pay both the employer and employee portions. If you work from home, some of your expenses may be tax deductible—but perhaps not as many as you think. A financial advisor can advise you on what to expect by way of tax deductions and how to document your expenses to comply with IRS regulations. He or she may even recommend you form a Limited Liability Corporation (LLC) to take advantage of tax savings opportunities and legally separate your personal assets from your business assets.

Spending for Growth

The old adage—it takes money to make money—holds true in the gig economy. Budgeting and saving money are essential conservative strategies that empower you to make riskier, but potentially more lucrative financial decisions. As a freelancer, you should apply a litmus test to every business expenditure you’re considering. Ask yourself, “Can I reasonably expect a return on this investment? How much and how soon?” Pursuing training to add to your skill set, hiring a designer to create a killer website for you, or purchasing a faster lens for your digital SLR may all be wise moves. Faithfully aligning spending with growth will keep you moving in the right direction: upward.

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